How The New Tax Laws Affect Your Meals And Entertainment Deductions For 2018
For business owners, entertaining and dining with clients, vendors and potential employees is a successful strategy for building strong business relationships. While these expenses are essential for your business to run smoothly, the related tax benefits may be long gone thanks to tax reform. By now, every business owner should be aware of the once-in-a-generation tax law changes that were passed at the end of 2017. But small business owners might not be fully aware of how these changes apply to their meals and entertainment (M&E) expenses. While a detailed analysis of tax reform as a whole is too much to digest for any one article, let’s take a look at how the new M&E rules affect your business.
Under prior law, you could generally deduct 50% of meals and entertainment expenses, unless a specific exception applied in which they would be 100 deductible. The IRS has clarified that meals are food or beverages, and entertainment is pretty much anything of entertainment, amusement or recreational value. These definitions were intentionally vague, and the list of exceptions for full deductibility included office holiday parties as well as meals, snacks and beverages considered to be fringe benefits.
Tax reform has eliminated the tax deduction for most business entertainment expenses. But there are always exceptions to the rule, and this one is no different. These are the nine exceptions:
1. Food and beverages for employees: These amounts may still be deductible if there’s a business purpose.
2. Expenses treated as compensation: Entertaining employees will be fully deductible.
3. Reimbursed expenses: Expenses that are not treated as compensation and are reimbursed by customers are fully deductible.
4. Recreational expenses for employees: Examples including facilities maintained by the business and company outings such as company picnics are fully deductible.
5. Employee, stockholder, etc., business meetings: Bona fide business meetings of employees or shareholders are considered fully deductible. For C corps and S corps that are required to hold periodic board meetings, this exception offers significant tax savings.
6. Meetings of business leagues: These resemble club dues but the organization must be qualified 501c(6) nonprofit and not just a social in nature. For sole proprietors and LLCs, this is significant, as they rely on many of these organizations to support their business.
7. Items available to public: Food and beverages given to the general public are considered fully deductible.
8. Entertainment sold to customers: If entertainment is purchased to be sold to customers it is not subject to limitation.
9. Expenses includible in the income of persons who are not employees: Similar to exception No. 2 but for contractors or other parties.
Another exception to the disallowed entertainment deductions was recently clarified to exempt certain entertainment expenses that are ordinary and necessary in the course of business. For example, theater tickets would generally be considered an entertainment expense for most companies. But for someone who is a professional journalist or critic, these expenses are ordinary and necessary to perform their income-generating work. In this example, the expense would be considered fully deductible.
Business meals with clients are still 50% deductible, but there are new stipulations to meet the business meal threshold. The new tax law did not specifically address business meals with clients as meals or entertainment. Treasury will write regulations in the future, but for now, to be considered a business meal and not entertainment, there are four objective tests that will be used to make a determination.
1. The meal must take place between you or your employee(s) and a current or prospective client.
2. The expense is incurred at a restaurant and not an entertainment venue such as a nightclub, cocktail lounge or sports arena.
3. The meal is not lavish or extravagant under the circumstances.
4. There’s a reasonable expectation of deriving income or other business benefit from the meeting.
Perhaps the biggest limitation comes through employer-provided fringe benefits. Previously, you could fully deduct food and beverages provided to employees through a cafeteria, as well as other food and beverages at the workplace such as coffee and donuts, working meals and overtime meals. After tax reform, unless these are served as part of a recreational event, these expenses are only 50% deductible. Ultimately, this makes employer-provided fringe benefits more expensive on an after-tax cost basis.
While not specifically related to M&E, the same code section of the law now also disallows deductions for transportation fringe benefits such as transit passes and employee parking. To see tax savings, business owners could include these amounts as compensation to take advantage of the exceptions stated above.
Record Keeping = Tax Savings
Now more than ever, companies need to understand their M&E expenses and ensure they are properly categorized and deducted to maximize tax benefits. Companies should review the tax treatment of their M&E expenses to capitalize on the limitation exceptions as well as work to minimize their nondeductible or partially deductible expenses.
To properly accomplish integrating tax reform changes, companies will need to make changes to their accounting and expense reporting systems and processes immediately. The most obvious change will come through granular ledger detail by expanding the chart of accounts to accurately categorize their M&E expenses.
At a high level, most entertainment expenses are nondeductible and most meals are 50% deductible. Previously, entertainment expenses were 50% deductible and a broader array of meals had the potential to be 100% deductible. The IRS is expected to heavily scrutinize this area of tax reform, so it’s important that your partners and employees properly enter and describe their activity in reporting expenses.