Back Again: Dutch-Treat Business Meals—but BewareTax Planning
If you go to a Dutch-treat lunch with a colleague or have a member lunch at your monthly chamber of commerce meeting, you face two opposing tax laws:
- The law that denies your deductions for personal living expenses (food)
- The law that allows business meals as tax deductions
Tax professionals know this conflict as the “Sutter rule,” named after Dr. Sutter, who had a bad experience with theTax Court. When the IRS and/or the courts invoke the Sutter rule, you lose your business meal deductions to theextent they don’t exceed your personal meal costs.
Example. Your Dutch-treat meal deductions for business entertainment for the year are $12,000. Had you had themeals at home, your cost would have been $2,000. Under the Sutter rule, the IRS could reduce your mealdeductions by $2,000, to $10,000—the business amount in excess of the personal cost that you proved.
It is unlikely, however, that you could prove your personal cost of meals. If that’s the case, then the IRS disallows$12,000—the usual result suffered by the victim of a Sutter attack.
- explains the Sutter rule,
- explains the triggers that can make you a target for a Sutter attack, and
- shows you how to keep your deductions if you are attacked.
In Dr. Sutter’s case, he lost the lunch deductions he claimed for attending St. Louis Chamber of Commerce and Hospital Council of St. Louis luncheon meetings. The court ruled that he did not spend any more money for those lunches than he spent for his personal lunches.
In a general comment to all taxpayers, the Sutter court stated that you can overcome the tax law’s no-deduction-forpersonal-expenses rule only by clear and detailed evidence that the expenditure in question was
- different from what you would have incurred for personal purposes, or
- in excess of what you would have spent for personal purposes.
Whimsical. The IRS invokes the Sutter rule at its whim. No standards exist, other than “abuse” in the eyes of the IRS.
Targets include the wrong types of business meals and/or too many business meals deducted. The problem: there is no definition of “too many.”
In Revenue Ruling 63-144, the IRS says that it applies this no-deduction rule for the personal cost of a meal (i.e., the Sutter rule) largely to abuse cases where taxpayers claim deductions for substantial amounts of personal living expenses.
It’s interesting that the IRS has applied the Sutter rule only to in-town business meals. It has not applied the rule to the cost of meals consumed while in travel status.
In Fenstermaker, the court ruled that the IRS policy of abuse cases was too liberal and applied a simple rule: no deduction for personal meals—period. In this case, the court denied 68 business lunches in one year and 49 business lunches in a second year because the cost of the business lunches was no greater than the cost of the taxpayer’s personal lunches.
In this case, Mr. Fenstermaker had both business and personal lunches at the Fort Hayes Hotel. Thus, the business lunch cost no more than a personal lunch, and accordingly the court ruled that Mr. Fenstermaker’s business lunches were not deductible.
Legitimate meal expenses have been under attack almost since inception of the income tax. Today is no exception.
But here you will learn how to build a good defense against such attacks.
Your defense comes in two forms: logic and legislation.
Under Sutter, in order for personal living expenses to qualify as deductible ordinary and necessary business expenses, you must demonstrate that the expenses were different from, or in excess of, what you would have spent for personal purposes.
If you have a number of deductible business meals with the same folks, you need to
- keep good business reasons for the meals; and
- have proof that because they were business meals, you spent more than you spend on personal meals.
You need this same proof if you are having a good number of Dutch-treat business meals.
The fact that you pick up the tab for only yourself at a tax-deductible business meal does nothing to hurt your business reason for the meal, but it can raise a suspicion that you are absorbing personal and family expenses.
To ensure your deduction passes muster, you must be able to show that when you go in on a Dutch-treat meal, you spend more than you would personally.
Put business first. Use the conduct of your business as your first rule of thumb. Every business is different. Every individual is different. You might have business meals often, and the next person not at all. It doesn’t matter. What matters is your proof. So build proof of your personal meal costs.
Let’s turn first to the legislation that’s on your side. First, you have the Tax Reform Act of 1986, where lawmakers stated that the cut from a 100 percent to an 80 percent business meal deduction simply reflects “that all meals and entertainment involve an element of personal living expenses.”6 Thus, you already have lawmakers saying that you
absorbed the personal part of a business meal with the cut to 80 percent.
In 1993, lawmakers reduced the 80 percent to 50 percent, believing this additional 30 percent reduction to be both an appropriate contribution on your part to reduce the deficit and a proxy for the personal consumption element of your meals and entertainment deduction.
But let’s not kid ourselves; there was only one reason for the cut from 80 percent to 50 percent: deficit reduction.
The personal consumption side was addressed in the 80 percent. Sad, but true! On the positive side, with the personal consumption element now at 50 percent, you have a much stronger defense against Sutter and Fenstermaker should the IRS try to impose these rules against you.
The Tax Cuts and Jobs Act removed business meals from the tax code’s definition of “entertainment” and from those directly related entertainment documentation rules of Section 274.
New final IRS regulations say that for you to deduct an in-town business meal, whether you pick up the tab or go Dutch treat, you must be with a person with whom you could reasonably expect to engage or deal with in the active conduct of your trade or business, such as your customer, client, supplier, employee, agent, partner, or professional advisor, whether established or prospective.
Documenting Your Business Meals
You need to keep records that prove your business meals are ordinary and necessary business expenses. You can accomplish this by keeping the following for each business meal:
- Receipt that shows the purchase (food and drinks consumed)
- Proof of payment (credit card receipt/statement or canceled check)
- A note that states the name of the person or persons with whom you had the meal
- Record of the business reason for the meal (a short note—say, seven words or fewer)
Example. You and Harry Smith, a client, have a Dutch-treat dinner that costs you $100. You write on the receipt: Harry Smith, client, $100 (my half), maintain relationship. You keep the receipt that shows the food and drink, and also the second receipt that shows the $100 charge to your credit card (assuming you and Harry split the charge with two credit cards).
Understand the Sutter rule. Named after Dr. Sutter's case before the Tax Court, the rule can deny deductions for business meals to the extent they don’t exceed your personal meal costs. It is important to understand this conflict between tax laws that deny deductions for personal living expenses (food) and those that allow business meals as tax deductions.
Identify the triggers. The IRS invokes the Sutter rule at its whim when it perceives abuse.
Formulate your defense. There are two main forms of defense against the Sutter rule: logic and legislation. The logic defense involves showing that your business meals cost more than your personal meals. The legislative defense hinges on noting for the IRS examiner that lawmakers reduced the business meal deductions to 80 percent and 50 percent to deny the personal benefit.
Document your business meals. You need records that prove your business meals are ordinary and necessary business expenses. You meet the rules when you have a receipt, proof of payment, name(s) of the person or people with whom you dined, and a record of the business reason for the meal.