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Businesses Need to Adapt to Major New Changes in Meals and Entertainment Tax Deductions

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When Congress enacted the Tax Cuts and Jobs Act (TCJA) in December 2017, it had to make difficult trade-offs, as popular deductions had to be sacrificed in order to obtain lower across-the-board tax rates. Lawmakers were concerned with the distributional effects; changes could not primarily favor high-income taxpayers over lower-income taxpayers, so restricting the meals and entertainment (M&E) deduction became a product of those trade-offs. The new tax law all but abolishes the deduction for entertainment, but keeps (with some new restrictions) the deduction for business meals.

Here is a breakdown of what these changes look like.

Entertainment Deduction

The new law repeals the deduction for business entertainment expenses, effective after December 31, 2017, except for certain employee events such as office parties. The deduction is allowed for recreational, social or similar activities that primarily benefit non-highly compensated employees.

Conversely, these types of expenses are no longer deductible:

  • Business entertainment expenditures at a social club, golf club or something similar, including dues and use fees.
  • Tickets to cultural events such as theater, opera and similar forms of entertainment.
  • Fees for outdoor activities such as hunting, fishing and sailing outings.
  • Sporting events tickets, including ticket costs, skybox expenses and transportation to the event.
  • Contributions to educational organizations for the right to purchase tickets to athletic events. Previously, these payments were deducted as charitable contributions, but they are no longer deductible.

Business Meal Deductions Cut Back

Business meals are still deductible, but the allowable percentage has changed for some categories.

Prior to 2018, a taxpayer could deduct 100% of meals provided to employees in employer-operated eating facilities. The new law reduces the deduction to 50% and repeals it completely in 2026.

It appears that taxpayers can still deduct 50% of business-related meals with clients and business associates as long as business is conducted, the taxpayer is present and the meals are not lavish or extravagant. The 50% deduction continues to be allowed for:

  • Cost of meals incurred during business travel.
  • Transportation to and from business meals.
  • Meals during stockholder, director or employee meetings.
  • Meals at conferences and business league meetings.
  • Meals included in charitable sports packages.

The 100% deduction for meals is still available for:

  • Expenses treated as employee compensation.
  • Reimbursed expenses.
  • Expenses for recreational, social or similar activities primarily for the benefit of employees.
  • Expenses for goods, services and facilities made available to the general public as paid entertainment.
  • Expenses for goods or services that are sold by the taxpayer in an arm’s length transaction.
  • Expenses includable in the income of persons who are not employees.

What does this mean moving forward? In order to implement the new tax law’s changes to the M&E rules, companies will need to review their treatment of expenses and make sure they are categorizing each expense correctly. Most notably, it is important for companies to segregate the cost of entertainment activities from the cost of meals. In addition, it may be useful to set up different categories for entertainment (nondeductible), business meals (50% deductible), recreational/social employee expenses and compensation/reimbursed expenses (100% deductible) as separate ledger accounts to accurately track proper deductions.

There remains a lot of uncertainty about how the new restrictions will apply in different situations. Eventual guidance from the IRS should help taxpayers get definitive answers to some of the deductibility issues for M&E expenses going forward. But for companies that have not yet addressed these significant changes, it is imperative they start now.

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statues, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

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