Hello everyone! Over the past several months I have been heavily asked questions by various business people about how the new tax laws (officially named the Tax Cuts and Jobs Act) will effect their businesses and specifically about business entertainment and its deductibility for taxes.
So, I thought that it would be helpful to address how business entertaining will be handled, for tax purposes, in tax years 2018 and beyond (or until Congress makes changes to the ‘new’ tax law effecting business entertaining).
Take note, that if you would like to learn more about the new tax law (or would like a refresher) I have written five articles giving a more in-depth look at the new tax law. You can read Part 1 here.
So, the rules surrounding business meals and entertainment have been complex for some time. It’s not so much what’s deductible and what isn’t, it’s the record keeping associated with the meals that is challenged most often by the IRS. You can only deduct 50% of the cost of most business meals and, in the past, entertainment. (There are some limited exceptions to the 50% rule for business meals).
The Tax Cuts and Jobs Act (TCJA), passed in 2017, generally disallows a deduction for expenses with respect to entertainment, amusement, or recreation. Entertainment has been defined to be any activity which is of a type generally considered to constitute entertainment, amusement, or recreation such as entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, or sporting events. The term “entertainment” may include an activity, the cost of which is claimed as a business expense by the taxpayer, which satisfies the personal, living, or family needs of any individual, such as providing food and beverages, a hotel suite, or an automobile to a business customer or the customer’s family. The term “entertainment” does not include activities which, although satisfying personal, living, or family needs of an individual, are clearly not regarded as constituting entertainment, such as (a) supper money provided by an employer to an employee working overtime, (b) a hotel room maintained by an employer for lodging of employees while in business travel status, or (c) an automobile used in the active conduct of trade or business even though also used for routine personal purposes such as commuting to and from work (but other rules apply in this situation).
Unfortunately, the TCJA didn’t specifically address the deductibility of expenditures for business meals. It seemed clear that meals out-of-town on a business trip or at a business convention were still deducible (subject to the 50% rule). But the question of whether or not taking a client to lunch was still deductible was unanswered because that can be construed as entertainment. The IRS has just issued some guidance, in the form of Notice 2018-76 (which you can read right here) in explaining its position on the issue. The notice also announced the IRS intends to publish proposed regulations which will discuss the deductibility of certain business meals. Until the proposed regulations are effective, taxpayers may rely on Notice 2018-76 for guidance.
Under prior law, entertainment expenses such as a ball game, theater tickets, etc. would be deductible only if the taxpayer could show the item was directly related to the active conduct of the taxpayer’s trade or business (“directly related” exception) or in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that the item was associated with the active conduct of the taxpayer’s trade or business (“business discussion” exception).
Example–The directly related exception applies if you take a client out to lunch or dinner and discuss business during the meal. However, the IRS does make a distinction between a meal at a restaurant and a meal at a facility that wouldn’t be conducive to a business discussion. For example, having dinner at a pub with entertainment. (But that might qualify under the second exception).
Example–The business discussion exception applies if you have a bona fide business meeting and thereafter take the client for a quiet business meal. For example, you drop in on a client to show him new services your company offers. You’re discussing business from three in the afternoon to five. You take the client out for a business meal, but don’t discuss any business at dinner.
The new law doesn’t change the definition of entertainment. The IRS has noted that the legislative history of the TCJA clarifies that taxpayers generally may continue to generally deduct 50 percent of the food and beverage expenses associated with their trade or business. The IRS intends to publish proposed regulations clarifying when business meal expenses are nondeductible entertainment expenses and when they are 50 percent deductible expenses. Until the proposed regulations are effective, taxpayers may rely on the guidance in Notice 2018-76.
Taxpayers may deduct 50 percent of an otherwise allowable business meal if:
- The expense is an ordinary and necessary expense, paid or incurred during the taxable year in carrying on a trade or business;
- The expenses is not lavish or extravagant under the circumstances;
- The taxpayer, or an employee of the taxpayer, is present at the furnishing of such food or beverages;
- The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
- 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.
Notice 2018-76 also says that the entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.
Requirements 1, 2, 3, and 4 above are not totally new. But, because of the overall new restrictions on entertainment, they may get closer scrutiny. The third item, requiring the taxpayer or an employee to be present is unlikely to cause a problem. But, you should be aware that you can’t just tell a customer to take his or her spouse with them to a local restaurant and put it on your tab and still get a 50 percent deduction.
Example–Bob invites Michael and Joseph, both customers of Bob’s company to a round of golf. After the game Bob buys lunch for the three of them at the golf club. The cost of the round of golf including any associated fees is entertainment and not deductible. The cost of lunch for the three, assuming all the other requirements are met, is deductible, subject to the 50 percent rule.
Example–Cindy invites Peter and Paul, both vendors for Cindy’s company to a football game. The company maintains a suite at the stadium and food and drinks are part of the cost of the suite. Since the food and drinks are not separately stated, none of the expense is deductible. If the food and drinks were separately billed, they would be 50% deductible.
While the notice answers some of the big questions, there are many nuances that it doesn’t. Many may be addressed in forthcoming regulations. The fact that entertainment is no longer deductible will affect trips on the company aircraft, deductions at country clubs, etc. The IRS may concentrate on finding any such disguised deductions when auditing 2018 and later year returns. Heavier scrutiny of meals could also be an expected consequence.
———–>Give Solid Tax Solutions (SolidTaxSolutions.com) a call at (845) 344-1040 to discuss the new tax rules and how it will affect you.
Bruce – Your Host at The Tax Nook
Our Firm’s Website: SolidTaxSolutions.com
Other Social Media Outlets: Facebook.com/SolidTaxSolutions.
Twitter: Twitter.com/@SolidTax1040 (BTW, We Follow-Back).