Professors Seek Withdrawal of Proposed Business Meals Regs

April 12, 2020

CC:PA:LPD:PR (REG–100814–19)
Room 5203, Internal Revenue Service,
P.O. Box 7604,
Ben Franklin Station,
Washington, DC 20044.

Dear Sir or Madam:

The undersigned are law professors who teach Federal Income Taxation.¹ We write to offer brief comments on REG-100814-19, the Proposed Rule on “Meal and Entertainment Expenses Under Section 274” (hereafter “The Proposed Rule”).

The Proposed Rule would allow partial deductions for business meal expenses, notwithstanding the unmistakably clear language of the 2017 revision to § 274 prohibiting any deduction for “entertainment,” a term which clearly encompasses many of the business meals authorized in the Proposed Rule. The Proposed Rule makes available new deductions for taxpayers even though the legislative history plainly expresses that the statute at best “still” allows taxpayers to deduct certain previously deductible expenses. We urge the IRS to follow the law as written and to prohibit deductions for meal expenses other than those permitted by enacted law. Doing so also avoids the unnecessary legal quagmires and economic distortions that the approach suggested in the Proposed Rule would entail.

First, the Proposed Rule's position is unlawful. Congress amended § 274 in 2017 to remove language permitting deductions for certain “entertainment” expenses. The amended § 274(a) now states, with certain enumerated exceptions, that “no deduction . . . shall be allowed for any item with respect to an activity which is of a type generally considered to constitute entertainment.” Consistent with the view that this prohibition bars deductions for business meals, Congress also deleted language in an associated provision, § 274(d), which required taxpayers to provide additional substantiation for such meals. The Proposed Rule requires one to assume that Congress intended not only to preserve an allowance for business meals, but also to permit that allowance to be claimed without substantiation. That reading defies both common sense and the country's ninety years of experience in administering business-meal deductions since Cohan v. Comm'r, 39 F.2d 540 (2d Cir. 1930).

In defense of its position, the Proposed Rule cites the Conference Committee Report for the proposition that “taxpayers may generally continue to deduct 50 percent of the food and beverage expenses associated with operating their trade or business.” 85 F.R. 11020, 11021 (citing H.R. Rep. No. 115-466, at 407 (2017) (Conf. Rep.)). When a statute's language is clear, however, it may not be amended through resort to legislative history. Wyeth v. Levine, 555 U.S. 555, 600 (2009).

The Proposed Rule states flatly that “the term 'entertainment' does not include food or beverages,” 85 Fed. Reg. 11020, 11022, but there is no question that the statutory word “entertainment” encompasses meals.² When § 274 was first enacted in 1962, the limitation on deductions for “entertainment” included several exceptions. The first of these was headed “Business Meals.” Pub. L. 86-834, 76 Stat. 960, 975 (Oct. 16, 1962). The second, still present in the modern statute at § 274(e)(1), states that the restriction of § 274(a) does not apply to certain “expenses for food and beverages.” These provisions can only be sensible if the term “entertainment” in § 274(a) covers meals. That understanding was clearly reflected in the legislative history of the 1962 statute. See H.R. Conf. Rep. No. 2508, 87th Cong., 2d Sess. 16 (1962) (noting that entertainment included events “at a restaurant”). And, of course, that same understanding has long been reflected in regulations. Treas. Reg. 1.274-2(b)(1)(i).

Aside from its allusion to the legislative history, the Proposed Rule gives no explanation at all for its failure to follow the statute's plain language, but Notice 2018-76 provided some clues. The Notice appeared to imply that Congress' failure to repeal § 274(k) permits a different result. That also appears to have been the conclusion of the JCT Blue Book. JOINT COMMITTEE ON TAXATION, GENERAL EXPLANATION OF PUBLIC LAW 115-97 (Dec. 2018). The Blue Book states: “A taxpayer may also continue to deduct 50 percent of the properly substantiated food or beverage expenses associated with a meal that is considered a business meal with a client, provided the business meal is not lavish or extravagant.” Id. at 189. Its only explanation for this conclusion is a footnote, which reads in its entirety, “See section 274(k), which was not amended by Pub. L. No. 115–97.” Of course, as a mere post-hoc summary of a statute unavailable to legislators at the time they voted, the Blue Book is even less authoritative than other forms of legislative history.

In any event, the fact that Congress failed to repeal §274(k) has no relevance to whether business meals are deductible. Section 274(k) provides only 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).” On its face, section 274(k) merely adds requirements that taxpayers must satisfy in order to be able to deduct meals. Nothing in it lifts a barrier to deduction imposed by other law. Its presence cannot authorize a deduction that would be prohibited by § 274(a).³ See Handelman v. Comm'r, 509 F.2d 1067, 1072 (2d Cir. 1975) (“Section 274 . . . is strictly a disallowance provision.”).

This obvious and longstanding understanding is reflected in existing regulations. If the interpretation evidently adopted by the Blue Book drafters and the Proposed Rule were correct, then it would have been the case that prior to 2018, any meal that was not lavish and enjoyed in the presence of the taxpayer or his employee would have been deductible by taxpayer. But of course, the regulations have long imposed all the requirements of § 274(a) on business meals, whether or not the taxpayer's employees are present. E.g., Treas. Reg. 1.274-2(c)(1); c(7) (the latter noting that absence of taxpayer or his employee is generally inconsistent with deduction).

An alternative reading that makes some sense of the Proposed Rule is that the Rule drafters understood Congress in 2017 to have intended to amend the meaning of “entertainment” in § 274(a) so that it does not encompass meals. That is an unlikely understanding of the relevant provisions, given the settled sixty-year-old meaning of “entertainment,” and the longstanding principles that statutory provisions cannot be effectively repealed by hints and indirection, Posadas v. Nat'l City Bank of N.Y., 296 U.S. 497, 504 (1936), and that Congressional revision is presumed to preserve prior interpretation, Shapiro v. United States, 335 U.S. 1, 15, 20 (1948); see Comm'r v. Kowalski, 434 U.S. 77, 92–93 (1977) (statutory use of “terms of art” incorporates by reference prior judicial gloss unless expressly repealed).

There is another glaring problem with such a reading: § 274(e)(1) is still in the statute. If § 274(a) does not encompass any deductions for food and beverages, then § 274(e)(1) is superfluous. There would be no need for a section stating “Subsection (a) shall not apply to . . . [e]xpenses for food and beverages furnished on the business premises of the taxpayer primarily for his employees.” Read in this light, § 274(k) can only be understood as an added set of requirements for the deductibility of meals, not an independent authorization to deduct meals.⁴

But perhaps the Proposed Rule 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 § 274(k) limited no meals because § 274(a) already barred such deductions. 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, too, is unavailing because there are a number of potential meals § 274(k) restricts that are not banned by § 274(a). Most obviously, §274(k) is applicable to meal and beverage expenses “which are directly related to business meetings of [taxpayer's] employees, stockholders, agents, or directors,” § 274(e)(5); see 274(k)(2)(A) (stating that 274(k)(1) does not apply to expenses described in §§ e(2), (3), (4), (7), (8), and (9)). Those meals are expressly not covered within the ambit of § 274(a). While the requirement of 274(k) that taxpayer or his employee be present is redundant in some instances to which 274(e)(5) applies, 274(k) may still serve as an added limitation in the case of stockholder or director meetings.

In addition, § 274(k) will still apply to any meal that falls into the exception under § 274(e)(1). 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, even when there are no employees of the employer present (for instance, if the meal is furnished by contract caterers). See Treas. Reg. 1.274-2(f)(2)(ii) (noting that exception applies “even though guests are occasionally served”). 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 Proposed Rule gives it. The Rule'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. No. 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 all meals, and to thereby make section § 274(e)(1) meaningless. See Shapiro, 335 U.S. at 15, 20; Kowalski, 434 U.S. at 92–93.

It might be argued that the meaning of the legislative history cannot be as simple as we 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.

Indeed, if anything the Conference Report is flatly inconsistent with the Proposed Rule. In essence, the Proposed Rule 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 business meals. That improbable outcome is belied by the Conference Report's statement that “[t]axpayers may still generally deduct . . . food and beverage expenses” (emph. added). “Still.” The Conferees, in other words, did not understand the legislation to allow food and beverage deductions that would not have been deductible in 2017.

Yet that is precisely what the Proposed Rule permits. New § 1.274-12 allows deductions for food and beverages “provided to a business associate,” as long as the requirements of § 274(k) are also met. “Business associate” is further defined as “a person with whom the taxpayer could reasonably expect to engage or deal with in the active conduct of taxpayer's trade or business, such as the taxpayer's customer . . . whether established or prospective.” That definition effectively overrules dozens of cases applying § 274(a), and thus seems a very unlikely understanding of the word “still.”

For example, the Proposed Rule would overturn with respect to meals the well-known result in Hippodrome Oldsmobile, Inc. v. United States, 474 F.2d 959 (6th Cir. 1973). As that court recognized, § 274(a) required “more than a general expectation” of future business in order for expenses incurred to be deductible. Id. at 964; see also Rowell v. Comm'r, 884 F.2d 1085, 1088 (8th Cir. 1989); Berkley Mach. Works & Foundry Co. v. Comm'r, 623 F.2d 898, 904–05 (4th Cir. 1980); Handelman v. Comm'r, 509 F.2d 1067, 1071–75 (2d Cir. 1975); see also Townsend Indus., Inc. v. United States, 342 F.3d 890, 897 (8th Cir. 2003) (concluding that expenditures would have been deductible under § 274(a) because specific taxpayer products and business practices were “discussed at length” during events).

Yet another factor suggesting that the Proposed Rule misreads the statute is that Congress eliminated meaningful substantiation requirements for business meals and beverages. The added substantiation rules of former § 274(d) were an essential component of the statute, adopted “to put an end to abuses which had developed through the use of expense accounts.” LaForge v. Comm'r, 434 F.2d 370, 372 (2d Cir. 1970). Congress specifically indicated that the general substantiation requirements of § 162 were inadequate for that purpose. Id. It is highly improbable, then, that the 2017 Congress could have intended to restore the free-wheeling and relatively unbounded rules for deducting meals that existed prior to 1962, while also repealing the need to specially substantiate these expenses — and all at the same time as it eliminated any deduction at all for entertainment. Cf. Kowalski, 434 U.S. at 94 (rejecting reading of § 119 that would expand deductibility of meal expenses “given the obvious intent of [the statute] to narrow the circumstances in which meals could be deducted”).

Moreover, the IRS and Treasury should avoid interpretations that result in unreviewable giveaways of taxpayer money, as the Proposed Rule does. Supreme Court precedent denies standing to the undersigned, or in all likelihood anyone else, to challenge the IRS's decision to grant deductions or other tax benefits unauthorized by law. Allen v. Wright, 468 U.S. 737 (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.

Finally, the Proposed Rule is bad tax policy. By creating a new disparity in the treatment of meals and entertainment, the Proposed Rule 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 Proposed Rule demonstrate that the regulations will treat differently two taxpayers who differ only in how their expenses are stated. Many merchants today do not separately price food and other services, and they presumably have good business reasons for doing so. Now, however, sensible vendors will price their goods in a way that generates tax benefits for customers, rather than the way that optimizes the business alone.

The Proposed Rule 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 Proposed Rule makes a small improvement over Notice 2018-76 by indicating that deductible food prices must reflect “usual selling cost” or “reasonable value.” Proposed § 1.274-11(b). There is, however, no theoretically correct method for apportioning overhead and labor costs between food and other aspects of an entertainment experience. When a caterer prepares food at a high-profile corporate event in a remote location, what portion of the upcharge is attributable to the “reasonable value” of the meal? The Proposed Rule invites unending litigation over how to appropriately divide costs that are not readily divisible.

As now written the Proposed Rule also invites abuse of or extensive litigation over the meaning of its central concept, “business associate.” This is defined as an individual with whom taxpayer “could reasonably expect to . . . deal with in the active conduct of taxpayer's trade of business . . . whether established or prospective.” The Proposed Regulation requires no other causal connection between meal and business. As many long years of experience before the adoption of § 274(a) demonstrated, such a standard cannot meaningfully be enforced. Business associates and co-workers routinely enjoy social events together. The Proposed Rule is also ambiguous on the question whether “established or prospective” describes the client relationship or also extends to the trade or business itself. Friends with no current business relationship can dream together about quitting their jobs and opening a bar in the tropics. Are those dreams “reasonable”? Who can say? The restrictions of § 274(a) were never airtight. But the requirement of a concrete business transaction, combined with the substantiation rules of former § 274(d), at least demanded that taxpayer produce documents to verify that a real transaction took place roughly contemporaneously with the meal. The Proposed Rule can be met with nothing but taxpayer wishes and caviar dreams.

In the event Treasury determines to go forward with guidance authorizing deductions that are prohibited by the statute, we also suggest clarifications to the current language. The main text of Proposed § 1.274-12(a) and the examples illustrating it are internally inconsistent. In addition, the Proposed Rule appears to opine on the scope of § 162 in ways that could have implications in many settings other than business meals. Treasury should either clarify that the Proposed Rule makes no new law on § 162 or call for additional comment on the implications of its rulings for other business settings.

First, it is not clear from the Proposed Rule whether it offers new guidance on the scope of § 162. If one accepts the Proposed Rule's position that “entertainment” does not include meals, there is no statutory authority (other than §§ 274(k) and (n)) for any limits on meal-related deductions that would satisfy § 162. It is therefore unclear on what basis, other than § 162, the Proposed Rule could limit deductions for meals to those provided to a “business associate.” Indeed, the Preamble apparently invokes § 162 as its source of authority for the definition of “business associate.” 85 Fed. Reg. 11020, 11023.

However, the language of the Proposed Rule appears to cover fact patterns that would at least arguably fall outside the traditional understanding of an “ordinary and necessary expense.” Expenditures to develop favorable reputations with “prospective” customers have been held not to be ordinary and necessary expenses, although of course with notable exceptions and inconsistencies. See, e.g., Welch v. Helvering, 290 U.S. 111, 115 & n.2 (1933); see generally George Mundstock, Taxation of Business Intangible Capital, 135 U. PA. L. REV. 1179, 1195–97 (1987) (summarizing untidy state of law at that time); Henry Ordower, Seeking Consistency in Relating Capital to Current Expenditures, 24 VA. TAX REV. 263, 264–66 (2004) (same). If such expenditures are not deductible under § 162, there should be no reason for the Proposed Rule to opine on whether they also clear the additional § 274(k) hurdle. A natural implication of the Proposed Rule, therefore, is that the Rule in fact holds that costs to develop reputation and good will are deductible expenses under § 162.

Such a holding could have important implications beyond the narrow context of business meals. If Treasury intends to opine on the meaning of “expense” in the Proposed Rule, Treasury should carefully consider how such a position relates to its guidance on related topics, such as advertising, business intangibles, education and job-seeking expenses, and the scope of the “repair” doctrine, among other issues. We believe it would be wiser not to address § 162 at all.

We also recommend careful reconsideration of the examples in Proposed § 1.274-12(a)(3). Example 2 presents facts that would readily have satisfied the former § 274(a). The example thus has the virtue that it accurately captures the meaning of the word “still” in the Conference Committee report. It makes no sense, however, as an illustration of Proposed § 1.274-12(a)(1), which makes no mention of the need for any concrete business transaction. What role, then, does the mention of the performance review play in Example 2? Is it intended to indicate a set of facts that would be necessary to satisfy § 162? Further clouding the analysis, the examples are introduced by a sentence stating that “the expenses are ordinary and necessary expenses under section 162(a).” If this premise is already taken as given, then it is unclear what analytical work is done by mentioning that the diners discuss employee's performance review.

Example 1 is similarly confusing. Like Example 2, it offers a fact that appears irrelevant under Proposed § 1.274-12(a)(1): “While eating lunch, A and B discuss A's trade or business activities.” The Proposed Rule does not state whether the discussion comprises negotiations over a current transaction or instead represents general business development, nor indeed even whether the activities discussed are relevant to client B at all. A reader could infer, then, that the Example holds that mere discussion of taxpayer's business with a client could be sufficient to satisfy § 162. But again, the reader cannot know whether such discussions are necessary to the deduction. As we have discussed, we believe such a low standard is wholly inadequate to protect the public fisc and is likely inconsistent with the historic meaning of § 162. But if that is Treasury's intent, it should say so clearly in the main text of the regulation, not through indirect hints in an Example.

Finally, the examples can be read to offer a broader deduction than is seemingly authorized by Proposed § 1.274-12(a)(1). Each example concludes that taxpayer “may deduct 50 percent of the food and beverage expenses,” which would seem to suggest taxpayer may deduct costs of taxpayer's own meal. Proposed § 1.274-12(a)(1) only authorizes a deduction for “food or beverages provided to a business associate.” As a practical matter this may make little difference, since taxpayers can easily game the limitation in -12(a)(1) by buying meals for each other. But it would be useful to at least clarify which taxpayer can claim the deduction for which meal.

* * *

In sum, the Proposed Regulation lacks any basis in statutory language or legislative intent. It discards decades of hard-earned wisdom on the capacity of taxpayers to manufacture “business” opportunities for tax gain. It will encourage manipulative pricing and waste scarce governmental and private resources in pursuit of a non-existent distinction between different kinds of entertainment. It further clouds an already-troubled area of tax law. Section 1.274-12(a) of the Proposed Regulation should be withdrawn, and the remaining portions of -12 consolidated with § 1.274-11.

Thank you for taking the time to consider these remarks. We are happy to answer any follow-up questions from you or your colleagues. Correspondence can be directed to brian.galle@georgetown.edu.

Respectfully submitted,

W. Edward Afield, Mark and Evelyn Trammell Professor and Director of the Phillip C. Cook Low-Income Taxpayer Clinic

Leslie Book, Professor of Law, Villanova University Charles Widger School of Law

Samuel Brunson, Georgia Reithal Professor of Law, Loyola University Chicago School of Law.

Adam Chodorow, Jack E. Brown Professor of Law and Associate Dean for Academic Affairs, Arizona State University Sandra Day O'Connor School of Law

Jonathan Choi, Classical Liberal Institute Fellow, New York University Law School, and Associate Professor (eff. 7/20), University of Minnesota Law School

Danshera Cords, Professor of Law, Albany Law School

Bridget J. Crawford, Professor of Law, Elisabeth Haub School of Law at Pace University

Tessa Davis, Associate Professor of Law, University of South Carolina School of Law

Mirit Eyal-Cohen, Professor of Law and Irving Silver and Frances Grodsky Silver Faculty Scholar, University of Alabama School of Law

J. Clifton Fleming, Jr., Ernest L. Wilkinson Chair & Professor of Law, J. Reuben Clark School of Law, Brigham Young University

Brian Galle, Professor of Law, Georgetown University Law Center

David Gamage, Professor of Law, Indiana University Bloomington Maurer School of Law

Andrew Hayashi, Class of 1948 Professor of Scholarly Research in Law, University of Virginia Law School

Young Ran (Christine) Kim, Associate Professor of Law, University of Utah S.J. Quinney College of Law

Hebert Lazerow, Professor of Law, University of San Diego Law School

Orly Mazur, Associate Professor of Law, SMU Dedman School of Law

Henry Ordower, Professor of Law, Saint Louis University School of Law

Erin Scharff, Associate Professor of Law, Sandra Day O'Connor College of Law, Arizona State University

Norman Stein, Professor, Kline School of Law, Drexel University; Douglas Arant Emeritus Professor of Law, University of Alabama School of Law

Michael Waggoner, Associate Professor of Law (Retired), University of Colorado Law School

Clint Wallace, Assistant Professor of Law, University of South Carolina School of Law

Elaine Waterhouse Wilson, Associate Dean for Academic Affairs and Professor of Law, West Virginia University College of Law

Kevin Yamamoto, Professor of Law, South Texas College of Law

Lawrence Zelenak, Pamela B. Gann Professor of Law, Duke University Law School9