This is the fourth installment of our monthly tax blog about the Tax Cuts and Jobs Act. In previous posts, we have discussed changes to tax rates, standard and itemized deductions, and the Section 199A or “pass-through” deduction.
In this post, we will look at changes to the deductibility of meals and entertainment expenses incurred by employers. The changes will become effective for tax years beginning after December 31, 2017.
Deductibility Under the Prior Rules
Previously, business owners were generally allowed to deduct 50% of expenses for qualified meals and entertainment, as long as the expenses were not lavish or extravagant. The definition of “entertainment” includes any type of event that would be considered recreation or amusement. For an expense to qualify, it was required to be directly related to or associated with the running of the employer’s business. For example, a business owner could deduct 50% of the cost of taking a client to a basketball game as entertainment expense if they engaged in a business discussion during the game.
Certain expenses for meals and snacks provided to employees and charitable sports events were 100% deductible under the prior law. There have been changes in these areas under the Act. Coming up in the next two sections, we will discuss which deductions have been eliminated completely and which deductions have been reduced.
Elimination of the Entertainment Deduction
The Act completely eliminates the 50% deduction for entertainment expense. The cost of tickets to events or admission to entertainment venues like clubs is no longer deductible. The change in the entertainment deduction has created some uncertainty for taxpayers about where the line is drawn between meals and entertainment. This is an important distinction, since business meals are still 50% deductible.
We are still awaiting further guidance from the IRS on the issue of which meals paid for during an entertainment outing will be nondeductible. Meals purchased for clients or prospective clients inside of an entertainment venue such as a theater, sports arena, or club are likely to be disallowed. Expenses incurred as part of an “entertainment event,” such as a meal at a restaurant prior to a round of golf, could potentially also be nondeductible. Many tax professionals believe that business meals occurring outside of an entertainment venue will continue to be 50% deductible, but the IRS has not clarified this issue yet.
Reduction in Certain Meals Deductions
Prior to the passage of the Act, certain expenses for food and beverages provided to employees were 100% deductible as long as they were excludible from employee income as a “fringe benefit.” Fully deductible expenses included:
- Meals provided for the convenience of the employer on the company’s premises. An example of this would be takeout dinners purchased for staff members who are staying late to complete a project before a deadline.
- Water, coffee, and snacks. For example, bringing bagels or donuts in for employees.
- Meals included as part of a charitable sporting event package.
Under the Act, these expenses are now only 50% deductible. They remain excludible from employee income if they qualify as a “fringe benefit.”
Meals That Remain 100% Deductible
Some meals that were fully deductible in previous years will still be fully deductible under the Act. The most common are:
- Meals provided at special employee events, such as a summer picnic, holiday party, or team-building challenge.
- Meals available to the public for free. For example, if an employer hosts a seminar open to the public, all food provided can be fully deducted.
- Meals included in the taxable compensation of employees or independent contractors.
Meals That Remain 50% Deductible
These items were 50% deductible before the Act, and will continue to be 50% deductible:
- Employee travel meals, such as dinner purchased by an employee who is out of town at a conference.
- Meals provided at a meeting of employees, stockholders, or directors.
- Meals with a client, as long as they are not lavish or extravagant and there is a business purpose.
Tax Compliance and Planning Considerations
Given the changes mentioned above and the uncertainty around which meals will be included as part of “entertainment,” it is important for you to carefully track your expenditures for meals and entertainment.
When the time comes to file your taxes, it will be important for compliance purposes to be able to separate expenses that are not eligible for the same level of deduction. For example, you will need to be able to distinguish the expenses paid for clients’ food inside of an entertainment venue (likely not deductible) from expenses paid for business lunches with clients (50% deductible). You should create separate categories in your accounting system for these costs.
Tracking your expenditures on entertainment and meals may also help you determine whether there is another type of expenditure that is more mutually beneficial for you and your employees. You may be able to shift some spending to an employee benefit that is both fully deductible to you and nontaxable to your employees, such as starting an employee retirement plan program like a 401(k).
If you have any questions regarding the changes to meals and entertainment deductions or other aspects of the Tax Cuts and Jobs Act, do not hesitate to reach out to us at Isler CPA.