The Consolidated Appropriations Act, 2021 (“CAA”) increased the business expense deduction for food or beverages provided by a “restaurant” from 50 percent to 100 percent through 2022. All other business meals deductions remain subject to the lower deduction percentage under the 2020 final meals and entertainment expense regulations, which were discussed in detail in a recent Virtual Coffee Talk. As a result, taxpayers were eagerly awaiting guidance on what constitutes a “restaurant” for this purpose. Last week, the IRS issued Notice 2021-25 (the “Notice”), which was intended to help delineate when the enhanced meals deduction does and does not apply. While the IRS may have had the best of intentions, the Notice leaves many taxpayers wondering whether or not their next meal is eligible for the temporary 100-percent deduction. In this alert, we highlight what we know as a result of the Notice as well as several outstanding questions upon which we hope the IRS will provide further guidance.
What Qualifies As a “Restaurant”?
Unfortunately for taxpayers, the Notice provides limited guidance as to whether a business qualifies as a “restaurant,” and it potentially places a large onus on consumers to ascertain whether certain meals will qualify for the temporary 100-percent deduction. Specifically, the only business that qualifies as a “restaurant” under the Notice is “a business that prepares and sells food or beverages to retail customers for immediate consumption, regardless of whether the food or beverages are consumed on the business’s premises.”
What Doesn’t Qualify As a “Restaurant”?
While the definition of “restaurant” is not overly helpful, the Notice does provide three examples of businesses that would not qualify as a “restaurant” for the CAA’s temporary 100-percent deduction. Such businesses include:
- “[A] business that primarily sells pre-packaged food or beverages not for immediate consumption, such as a grocery store; specialty food store; beer, wine, or liquor store; drug store; convenience store; newsstand; or a vending machine or kiosk.”
- “[A]ny eating facility located on the business premises of the employer that furnishes meals excluded from an employee’s gross income under section 119.”
- “[A]ny employer-operated eating facility treated as a de minimis fringe under section 132(e)(2), even if such eating facility is operated by a third party under contract with the employer as described in [Treas. Reg. section] 1.132-7(a)(3).”
What Do We Wish Were on the Menu?
As a result of the pandemic, we are all scrappy and hungry, but the IRS squandered its opportunity to make taxpayers’ lives easier in determining where to have their next business meal and to help stimulate the restaurant and foodservice industry as a whole. Instead, taxpayers are left with a host of questions, including:
- Who isn’t a “retail customer”?
The definition of “restaurant” focuses on the preparation and sale of food or beverages to retail customers for immediate consumption. However, this raises the question of who, other than a retail customer, would be claiming a business meal deduction. When thinking about who may not be a “retail customer,” it appears the reference may be intended to distinguish between retail customers and either wholesale customers or corporate customers (customers who make purchases on behalf of a company). If the intention was to exclude wholesale customers, it is unclear why the exclusion was even necessary. That is because a wholesale customer would be purchasing food or beverages either for its own benefit (in which case it would be acting as a retail customer and qualify for the enhanced business meals deduction) or for resale (in which case it would not be claiming a business meals deduction).
On the other hand, if the intention was to exclude corporate customers, then that exclusion could be more problematic for businesses that serve the corporate market, such as corporate caterers. These foodservice businesses would not qualify as “restaurants,” and meals purchased from them would, therefore, be ineligible for the temporary 100-percent deduction. If this analysis is correct, then what if a dine-in food business also offers catering? Are all meals, including catered meals, eligible for the 100-percent deduction, or are only those provided as dine-in? Exacerbating this uncertainty is that the 2020 final meals and entertainment expense regulations carefully distinguish between restaurants and caterers, and the CAA and the Notice refer only to restaurants and do not explicitly include caterers.
- What constitutes “pre-packaged food … not for immediate consumption”?
The Notice provides that a business that primarily sells pre-packaged food, not for immediate consumption, is not a restaurant. Unfortunately, however, the Notice does not define any of these phrases, leaving taxpayers the task of trying to discern what the IRS’ underlying intention was. Generally, pre-packaged foods are foods that are prepared in advance and put in a container to be sold. It would seem reasonable, then, that a business that “primarily” sells bags of chips or cans of soda should not be viewed as a restaurant. However, the Notice further narrows the scope of the exclusion only to businesses that sell pre-packaged food that is not for immediate consumption. The Notice includes, as an example, a vending machine or kiosk. But consumers usually immediately consume food or beverages sold via a vending machine or kiosk. So this begs the question, what was the intention of the “not for immediate consumption” limitation?
An additional question is how broadly does the “pre-packaged foods” definition apply. For example, if a business sells solely grab-and-go food offerings, where meals are prepared by a business but are pre-packaged for sale to consumers, does that business qualify as a restaurant because it prepared and sold the food? Or does it not qualify because it primarily sells pre-packaged food not for immediate consumption?
- What if a business sells prepared food or beverages as well as pre-packaged food not for immediate consumption?
For example, assume a business sells both food it prepares and pre-packaged food (for example, cans of soda and bags of chips). Are food or beverages purchased from this business potentially eligible for the 100-percent deduction? On the one hand, the business is a business that prepares and sells food. On the other hand, it is also a business that sells pre-packaged food that is not for immediate consumption. The Notice appears to require the consumer to determine whether the business “primarily” sells pre-packaged or prepared foods. If it does not primarily sell pre-packaged foods, then it appears that all food or beverages purchased from business, including the pre-packaged food or beverages, may eligible for the temporary 100-percent deduction. While in some cases that determination may be straightforward, in others, it could be more troubling. For example, consider a hot dog cart that sells hot dogs that the vendor prepares and sells, but also pre-packaged foods and beverages. Is the “primarily” determination based on quantity, gross revenue, or net revenue? Because the onus is on the taxpayer to substantiate the deduction, how will a taxpayer document and substantiate its determination as to whether the business primarily sells hot dogs or pre-packaged foods?
Another interesting example is a hotel that offers room service and operates a gift store that sells, among other things, pre-packaged food. Are the food or beverages sold through room service or by the gift store eligible for the 100-percent deduction? Does the fact that the business (the hotel) also offers non-food-related items (in this example, hotel rooms) affect the analysis, or is the analysis limited to food- or beverage-related items?
- If so, then it appears that all food or beverages sold, including the pre-packaged food sold through room service and by the gift store, would be eligible for the 100-percent deduction.
- If not, then the consumer would have to determine whether the business primarily sells prepared food through room service or pre-packaged food by the gift store.
- What if the food or beverages are purchased through an agent, as opposed to from the “restaurant” directly?
For example, what if the hotel purchases its room service food from another business and, therefore, does not prepare the food but only sells it? Is the food still sold for immediate consumption even though it was not prepared by the business, or is it more akin to a vending machine or kiosk, and therefore not eligible for the CAA’s temporary 100-percent deduction? It appears that under the Notice, such food would not be eligible for the enhanced deduction.
This then raises the question of whether food or beverages purchased via a delivery service qualify. In that case, the food or beverages are technically being bought from the delivery service. The consumer does not have a direct relationship with the business that prepared the food, and the receipt is from the delivery service, instead of the underlying food establishment. Does that mean that because the delivery service is merely selling, rather than both preparing and selling, the food or beverages, purchases made through the service are not eligible for the temporary 100-percent deduction? It would seem that this should not be the case, but based on the Notice, the result is certainly unclear at best.
- What if a business (Business 1) that would otherwise not qualify as a restaurant (for example, a grocery store) subleases some space within its premises to another business (Business 2), which prepares and sells food or beverages to retail customers for immediate consumption?
Based on the Notice, it would appear that food or beverages purchased from Business 2 would qualify for the CAA’s temporary 100-percent deduction. However, how would a consumer know if Business 2 is really a separate and distinct business from Business 1? Is it a matter of what business’ name is on the receipt? What if Business 2 accepts Business 1’s gift cards?
- What documentation does a consumer need to support its determination that it purchased a business meal from a “restaurant”?As discussed previously, taxpayers are now required to broaden the scope of their documentation to substantiate their meal expense deductions. What details does a taxpayer need to maintain regarding a business’ restaurant qualification?
A&M Tax Says
The CAA’s temporary 100-percent deduction was intended to stimulate the food and beverage industry. However, many questions of interpretation related to the statutory language remain outstanding. On top of that, the onus is on the consumer to substantiate expenses that qualify for the 100-percent deduction. The IRS did not do consumers any favors as the limited guidance it gave is ambiguous at best, and at worst saddles taxpayers with the often impossible task of determining eligibility for the full deduction. For example, based on the Notice, a hot dog cart may not qualify as a restaurant because it may primarily sell pre-packaged food, such as chips and beverages (similar to a newsstand), whereas a food truck or food stand would likely qualify as a restaurant. As a result, consumers are left wondering what additional documentation they must maintain to support their deduction, in addition to the existing requirement that they retain a detailed receipt that lists who was at the meal and its purpose.
Please contact your trusted A&M Tax adviser if you have any questions regarding the Notice, including whether and how it applies to your particular situation.