May an employer deduct holiday party expenses?
Question of the week: Can an S corp deduct the entire cost of holiday parties for the whole staff and planning sessions only for owners of the S corp?
Q. Can an S corp deduct the entire cost of a holiday party for the whole staff and planning sessions for owners?
An S corp client, Pipes, Inc., is a large plumbing supply company with five owners and 30 employees. Eli, who is one of the owners, has asked about expenses for the company’s employee events under the new food and entertainment rules. For example, although it may not happen this year, the company typically has a holiday party at a hotel. The company pays the cost of the buffet dinner and drinks for the entire staff which includes sales, administrative support, warehouse operations, and bookkeeping. The hotel charges a room rental fee. Also, Pipes has one or two planning meetings during the year, usually at a nice restaurant. The planning sessions are only for the five owners. Each owns a 20% share of the company and is an active employee who receives a salary. Can Pipes deduct all of the event costs, or just 50% of the costs, or are all of these costs non-deductible?
A. The company may be able to deduct 100% of the cost of a holiday party but the deduction for planning session expenses is limited.
From your description it appears that Pipes Inc.’s holiday party is fully deductible, but the planning sessions are only partly deductible.
Meals and entertainment under the TCJA
Under the TCJA’s meals and entertainment expense rules and recently issued final regulations, no deduction is allowed for the cost of any activity considered to be entertainment, amusement, or recreation, including facilities used in connection with entertainment. Entertainment does not include the cost of food and beverages provided at an entertainment activity as long as the food and beverages are purchased or invoiced separately and other requirements for this category are met (not extravagant or lavish, provided for the taxpayer, employees, etc.) Generally, only 50% of the cost of food and beverages is deductible.
Recreational expense exception. There are several exceptions to the meals and entertainment expense limitations that were not modified by the TCJA. One such exception (§274(e)(4)) is for recreational expenses for employees. The exception means that expenses for recreational, social, or similar activities primarily for the benefit of employees, other than events solely for highly compensated employees, are not subject to meals and entertainment expense deduction limits. Examples include holiday parties, annual picnics, and so on.
If the exception applies, both the general prohibition on deducting entertainment expenses, including the cost of facilities used for entertainment, and the 50% limitation on deducting food and beverage expenses do not apply.
For this purpose, a highly compensated employee is an individual owning 10% or more of the business or who has compensation over $130,000 (for 2020). Primarily for the benefit of employees doesn’t mean all employees must attend the event or that highly compensated employees can’t attend the event. Rather, the event cannot discriminate in favor of highly compensated employees.
Deductions for the company holiday party and the planning events
Because Pipes, Inc. invites its entire staff to the holiday party at a hotel or other venue, the §274(e)(4) exception applies. Therefore, the entire cost of the event, including 100% of the cost of food and beverages and any charge for the room rental is fully deductible. It does not matter that the owners attend the party too or if some employees earn more than the $130,000 limitation because the holiday party is a recreational event primarily for the benefit of employees.
On the other hand, only Pipes, Inc.’s owners are invited to the planning sessions. The §274(e)(4) exception does not apply because these events are not primarily for the benefit of employees. Although the exception doesn’t apply, Pipes, Inc. may still deduct 50% of the cost of food and beverages served at the planning sessions.