For many businesses, dinners with clients or entertaining prospects on golf courses or sporting events are normal business practices, and in certain cases even necessary. However, beginning in 2018, business leaders should be aware of some key changes to the deductibility of business meals and entertainment expenses as a result of the Tax Cuts and Jobs Act (TCJA). While the IRS has yet to issue proposed regulations, they recently provided initial guidance on business expense deductions for meals and entertainment through Notice 2018-76. Below is a summary of what is changing and what is staying the same.
Entertainment Expenses Are No Longer Deductible
The 2017 TCJA eliminated the deduction for any expenses related to activities generally considered entertainment, amusement or recreation. Before the tax laws changed, up to 50 percent of entertainment expenses were deductible as long as the expense was either directly related to the active conduct of the taxpayer’s trade or business or in the case of an item directly preceding or following a substantial and bona fide business discussion, that the item was associated with the active conduct of the taxpayer’s trade or business. This included entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacation and similar trips if there was a substantial business discussion before or after the entertainment.
Business Meal Expenses Remain Deductible
In Notice 2018-76, the IRS provides the following as guidance for when taxpayers may deduct 50 percent of an otherwise allowable business meal expense:
1. The expense is an ordinary and necessary expense under IRC Sec. 162(a) paid or incurred during the taxable year in carrying on any trade or business;
2. The expense is not lavish or extravagant under the circumstances;
3. The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
4. The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
5. In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts.
Meals Provided for the Convenience of the Employer
Qualified cafeteria expenses and the provision of meals for the convenience of the employer are no longer fully deductible starting in 2018. Instead, these expenses will generally be limited to 50 percent until 2025. After that, meals provided for the employer’s convenience will be considered nondeductible expenses.
Other Expenses That Remain Fully Deductible
While tax reform brought about some significant changes to meals and entertainment expenses, businesses should note that certain qualified expenses continue to be 100% deductible. Some fully deductible expenses include:
• Amounts reported as compensation to an employee
• Reimbursements reported as compensation or for which an independent contractor does not supply adequate substantiation.
• Expenses for items made available to the general public (e.g. promotional popcorn or distribution of samples)
• Expenses related to recreational, social or similar activities incurred primarily for the benefit of employees other than highly compensated employees (e.g. holiday parties and company picnics)
With tax reform changes to meals and entertainment expenses, businesses must be clear about what qualifies as deductible expenses. The burden of proof is ultimately on the taxpayer to establish the deductibility of their business expenses. Thus, it’s critical for business owners to keep track of their deductible meal expenses as well as their non-deductible entertainment expenses. By adequately documenting these expenses, businesses will be able to substantiate their expenses should a tax audit ever arise.
Still have some questions? We’d be happy to discuss this new law change as it relates to you and your business.