Tax Reform: Major Changes to Meal and Entertainment Expenses

The Tax Cuts and Jobs Act (TCJA) largely eliminates the deduction for entertainment expenses. While there are a few unanswered questions (specifically how this provision affects meals), its effect is immediate. As a result, businesses should incorporate this change without delay.

The Change

Under prior law, taxpayers were entitled to deduct 50 percent of expenses incurred for entertainment, amusement, or recreation directly related to the active conduct of a taxpayer’s trade or business. Under the new law, this deduction is generally eliminated for expenses paid or incurred after Dec. 31, 2017.

Does This Change Affect Meal Expense?

Absent a few exceptions (outlined below), entertainment expenses are nondeductible in 2018. Accordingly, a deduction is not permitted for client entertaining at sporting events, on the golf course, or any similar entertainment expense. This is clear. What is less clear is how this provision affects food and beverage expense (or meals). The Joint Committee on Taxation, commenting on the TCJA, stated that “[t]axpayers may still generally deduct 50 percent of the food and beverage expenses associated with operating a trade or business.” However, they did not define what expenses were associated with ‘operating a trade or business’ other than to say that this would include meals provided to employees traveling in the course of their work. It is not clear whether food and beverage expenses incurred in connection with an entertainment event would remain 50 percent deductible. However, we believe that the expense of these meals would be incurred in ‘operating a trade or business’ and thus entitled to a 50 percent deduction, but until we are afforded guidance on this issue, we caution that some degree of uncertainty exists.

Recommendation

We therefore recommend separate general ledger accounts for entertainment expenses and food and beverage expenses. This way, to the extent a 50 percent deduction is permitted for food and beverage expense, it will be separated from the clearly nondeductible entertainment expense.

Unaffected Deductions

Although many entertainment expense deductions have been disallowed, some remain unchanged. One such exception is for recreational and social events incurred for the benefit of employees. A common example is the use of entertainment tickets by employees. Where an employer makes tickets available for the use of employees (so long as the employer does not favor highly compensated employees), the cost is likely deductible. Another exception is for recreational and social events such as holiday parties, annual picnics, or summer outings.

Provided below is a list of additional exceptions that are not affected by the new law:

1. Food and beverage for employees furnished on the business premises of the taxpayer primarily for employees.
2. With some exceptions, meals and entertainment expenses treated as compensation to an employee.
3. Employees and independent contractors are entitled to a full deduction for meals and entertainment expenses for which they were reimbursed by another person (whether or not such other person is the employer).
4. Expenses incurred for recreational, social, or similar activities primarily for the benefit of employees. This exception does not include expenses incurred for the benefit of highly compensated employees.
5. Expenses incurred by a taxpayer which are directly related to business meetings of employees, stockholders, agents, or directors.
6. Expenses which are directly related, and necessary, to attendance at a business meeting or convention of tax exempt business league or other organization described in IRC section 501(b)(6).
7. Expenses for goods, services, and facilities which the taxpayer makes available to the general public.
8. Expenses for goods and services which are sold by the taxpayer. For example, the cost of operating a cruise ship will be deductible because the cruise ship’s entertainment is being sold to customers.
9. Expenses includible in the gross income of a recipient, who is not an employee of the taxpayer, as compensation for services rendered or as a prize or award.

Food or beverage expenses falling within the exceptions described in 2, 3, 4, 7, 8, or 9 above will not be subject to the 50 percent limit, meaning they are fully deductible.