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.
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 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:
The 100% deduction for meals is still available for:
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.
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