Section 274: Rules on Entertainment, Meal, and Expense Deductions

Businesses often incur expenses for meals, entertainment, and other costs related to client relationships or employee engagement. However, not all of these expenses are tax-deductible. The IRS has strict rules under Section 274 of the tax code that determine what qualifies for deductions.

Meal vs. Entertainment Expenditures

The IRS differentiates between meal and entertainment expenses. Meals are generally 50% deductible if they are ordinary, necessary, and directly related to business activities. This includes client dinners, employee meals during business travel, and food at conferences. However, meals cannot be lavish or extravagant based on the circumstances, requiring reasonable judgment.

Entertainment expenses, such as tickets to sporting events, concerts, or golf outings, are not deductible under current tax law. The Tax Cuts and Jobs Act (TCJA) of 2017 eliminated deductions for entertainment, amusement, or recreation, even if directly related to business discussions.

Some expenses fall into a gray area between meals and entertainment, requiring careful classification. For example, if a business owner takes a client to a baseball game and buys food separately, the meal portion may qualify for a 50% deduction, while the ticket cost remains non-deductible. Proper documentation, such as itemized receipts, is necessary to support this distinction.

Criteria for Substantiation

To claim deductions, businesses must meet strict substantiation requirements. Proper documentation is necessary, and failing to maintain adequate records can lead to disallowed expenses and penalties.

For an expense to be deductible, businesses must provide evidence detailing the amount, time, place, and business purpose. Receipts, invoices, or other supporting documents must show the cost, date, and location of the transaction. Additionally, records should indicate the individuals involved and their relationship to the business. A general note like “client meeting” is insufficient—specific names and the nature of the business discussion must be included.

The IRS requires contemporaneous recordkeeping, meaning documentation should be created at or near the time of the expense. Delayed recordkeeping increases the risk of inaccuracies and weakens the credibility of the claim. Digital tools, such as expense-tracking software and mobile apps, can help businesses maintain organized records and generate detailed reports that comply with IRS standards.

Club Dues Treatments

Membership dues paid to social, athletic, or sporting clubs are generally non-deductible, even if they provide networking opportunities. This includes payments to golf clubs, athletic facilities, and similar organizations. The IRS considers these expenses inherently personal rather than necessary business costs.

However, dues paid to professional organizations, such as bar associations, trade groups, or chambers of commerce, may qualify for deductions if they directly relate to business activities. These organizations often provide industry resources, continuing education, and networking opportunities, which the IRS recognizes as legitimate business expenses. The key distinction is whether the organization exists primarily for social or recreational purposes—if so, the deduction is disallowed.

Employers offering gym memberships or wellness programs as part of an employee benefits package must also follow specific tax rules. If the benefit is provided on-site and primarily promotes employee health, it may be excluded from taxable wages. However, reimbursing employees for external gym memberships is generally considered taxable compensation unless it qualifies under a specific wellness program exemption.

Gift Expense Restrictions

Businesses often use gifts to strengthen relationships with clients, vendors, and employees, but the IRS imposes strict limits on their deductibility. The maximum deduction allowed for business gifts is $25 per recipient per tax year. This cap applies regardless of the actual cost of the gift, meaning if a company spends $100 on a client’s gift, only $25 is deductible. Incidental costs such as engraving, packaging, or shipping are not included in the $25 limit, provided they do not substantially increase the gift’s value.

The definition of a “gift” for tax purposes excludes items that qualify as promotional materials or widely distributed goods. Branded merchandise, such as company-logo pens or calendars, may be fully deductible if they are given in bulk and cost less than $4 per item. Similarly, awards for employee achievement, such as length-of-service or safety awards, may be deductible under separate provisions if they meet specific criteria.

Restrictions on Transportation Expenses

Certain transportation costs may be deductible, but Section 274 imposes limitations to prevent excessive claims. Businesses must differentiate between local commuting expenses, which are generally non-deductible, and travel costs incurred for business purposes, which may qualify for deductions if properly substantiated.

Commuting expenses between an employee’s home and regular workplace are considered personal and cannot be deducted, even if the employee works late or carries business materials. However, travel between multiple business locations during the workday is deductible. If an employer provides transportation benefits, such as transit passes or parking allowances, these may be excluded from employees’ taxable income up to the IRS-set monthly limits ($315 for qualified parking and $315 for transit benefits in 2024).

For business-related travel, expenses such as airfare, lodging, and rental cars are deductible if necessary and directly related to business activities. The IRS requires that travel be “primarily” for business, meaning more than 50% of the time must be spent on work-related activities. If a trip combines personal and business purposes, only the business portion is deductible. Employers must also ensure that reimbursements follow an accountable plan to avoid being treated as taxable income to employees.

What Happens If You Don’t Comply

Failing to comply with Section 274’s requirements can result in disallowed deductions, increased tax liability, and penalties. The IRS closely scrutinizes business expenses, and inadequate documentation or improper classification can trigger audits or adjustments.

If deductions are denied, businesses may face additional tax assessments, interest charges, and penalties for underpayment. In cases of willful misrepresentation, such as inflating expenses or misclassifying entertainment as meals, penalties can be severe, including accuracy-related penalties of 20% of the underpaid amount or even fraud penalties of 75%. Employers that improperly reimburse employees under a non-accountable plan may also create unintended tax consequences, as these payments become taxable wages subject to payroll taxes.