The law known as the Tax Cuts and Jobs Act (“TCJA”) made several changes to deductions for meal and entertainment expenses paid or incurred after 12/31/2017, an area that affects a majority of businesses. Certain expenses that were previously either 100% or 50% deductible are now 50% deductible or fully nondeductible. Most impactful or surprising may be the full disallowance of certain expenses deemed as entertainment that were previously 50% deductible.
Historically, “meals and entertainment” have gone together so well that many considered them one in the same, even though difference subsections within IRC Sec. 274 governed their general deductibility. Now, the two still share commonalities in certain situations, but have been effectively separated by the new general disallowance of entertainment expenses.
While many businesses had policies and separate accounts to track various meal and entertainment activities before the TCJA, now is potentially an even more important time to ensure those practices are in place. This article is going to cover the entertainment rules and the nine exceptions to the general disallowance.
Before the TCJA, entertainment expenses were generally disallowed under IRC Sec. 274(a)(1)(A), with two exceptions:
- The item was directly related to the active conduct of the taxpayer’s trade or business (the directly related exception), or
- The item directly preceded or followed a substantial and bona fide business discussion (the associated with exception).
If the activity met one of those exceptions, a deduction was generally allowed, subject to a 50% limitation under IRC Sec. 274(n)(1). However, IRC Sec. 274(a)(1)(A) now disallows deductions for activities that are considered to be entertainment, amusement, or recreation without the availability of the directly related or associated with exceptions. Also, IRC Sec. 274 (n)(1) was amended by the TCJA to remove the reference to entertainment expenses, leaving them as nondeductible expenses.
Although the deductibility of entertainment changed with the TCJA, the definition has not at this point. Therefore, previously applicable guidance may still be used in determining the types of activities subject to the entertainment limitation. Reg. 1.274-(b)(1)(i) provides the definition of entertainment as activities at night clubs, cocktail lounges, theaters, country clubs, golf and other sporting events, as well as such activities relating solely to the taxpayer or his or her family. Expenses satisfying the personal, living, or family needs of any individual (such as meals, auto, or lodging to the business customer or his or her family) also are considered entertainment. However, items that are clearly not entertainment, like supper money to an employee working overtime or a hotel room maintained for employee lodging while travelling for business, are not considered entertainment.
Reg. 1.274-2(b)(1)(ii) states that an objective test shall be used to help determine if an activity is generally considered entertainment, noting that the taxpayer’s trade or business shall be considered in this determination. For example, while attending the theater would generally be considered entertainment for most taxpayers, it would not be so for a professional theater critic who is attending in a professional capacity.
In addition, IRC Sec 274(e) lists the following nine exceptions to the general disallowance rule under IRC Sec. 274(a). Knowledge of these rules is important as it lays out some opportunities for a tax deduction that may not be available at first glance.
- Food and beverages for employees, including expenses for related facilities, furnished on business premises.
Example. Coffee, soft drinks, snacks, etc. provided by the company for use by the employees at no charge. Deduction limited to 50%.
- Expenses treated as compensation.
Example. Company purchases sales staff season tickets to a sporting event and includes the amount paid as wage compensation, subject to tax withholding and reporting amount on W-2. Deduction allowed at 100%.
- Reimbursed expenses under an accountable plan.
Example. Company reimburses an employee for meals incurred while traveling, provided the employee submits receipts to the company.
If Company does not bill a client for the meals, the deduction is 50%. If the Company does bill a client for the meals, and the meals reimbursement sought is clearly delineated on the billing, the deduction is 100%.
- Expenses for recreational, social, or similar activities primarily for the benefit of employees.
Example. Company holds an annual holiday party which is attended by almost all of its employees. Deduction allowed at 100%.
- Expenses directly related to business meetings of employees, stockholders, agents, or directors.
Example. Company holds a meeting at the beginning of the year at a hotel to discuss policy and procedures for the upcoming year. Expenses incurred in association with holding the meeting are deductible at 100%.
- Expenses related to attending business meetings or conventions of any Section 501(c)(6) organization (e.g., business leagues and chambers of commerce).
Example. Company sends employees to a business convention. Deduction allowed at 100%.
- Expenses for items made available to the general public in a bona fide transaction for full consideration.
Example. Company maintains a swimming pool as part of its business, and makes it available to the public. Deduction allowed at 100%.
- Entertainment sold to customers in a bona fide transaction for full consideration.
Example. Company operates a pleasure cruise ship as a business. Deduction allowed at 100%
- Expenses includible in income of persons who are not employees of the taxpayer.
Example. Company has expenses related to sending a customer’s spouse to a conference, and company adds such expenses to a form 1099-MISC as income to the customer. Deduction allowed at 100%.
With all of the changes made by the TCJA, it is important to understand the new expense rules and limitations for meals and entertainment. Business owners should seek guidance from experienced tax advisors to assist them in navigating these limitations. Please contact DMJ if you have any questions.