News & Insights
When is entertainment an expense and are client meals deductible after the Tax Cuts and Jobs Act?
The tax rules related to meals and entertainment have changed, and left some uncertainty in the gap between the old law and the new. Before the Tax Cuts and Jobs Act, the deduction allowed for entertainment expenses was limited to 50 percent of the amount otherwise deductible. Under the TCJA, the deduction for entertainment is completely repealed. Prior to the act, a 50 percent deduction was allowed for expenses related to business meals that were not lavish or extravagant. The confusion results from the issue of whether such business meals fall under the entertainment umbrella, or are still deductible.
Under prior law, a taxpayer could deduct 50% of entertainment, amusement, or recreation expenses incurred for activities that were directly related to (or associated with) the active conduct of its trade or business, or a facility used in connection with such activity. For amounts paid or incurred after December 31, 2017, unless otherwise noted below, the 2017 tax reform reconciliation act, also known as the ‘Tax Cuts and Jobs Act’ (the Act), has eliminated the deduction for expenses related to entertainment, amusement, or recreational activities. The Act also significantly limits an employer’s ability to fully deduct expenditures associated with de minimis fringe benefit meals, as well as meals provided for the convenience of the employer at an employer-operated eating facility. The wage exclusions for these benefits are not be impacted; therefore, such benefits remain excluded from employee wages.
The new law now raises the question of what is an entertainment expense. Entertainment is defined as any activity that is of a type generally considered to constitute entertainment, amusement, or recreation, including entertaining at theaters, clubs, lounges, and sporting events. Taxpayers have to be certain as to what falls under that category. It made no difference before, since there was a 50 percent deduction either way. Now, if it’s entertainment, it’s totally nondeductible. Until the IRS comes out with guidance in the area, the confusion will remain.
It comes down to intent – are you really entertaining customers or are you having a business discussion to solve an issue? Documentation is increasingly important this year, as it will provide more opportunity to deduct items now considered ‘gray area’ due to the vague rules.
And contrary to common misconceptions, internal expenses such as holiday parties, and team-building outings that boost employee morale are still fully deductible. Consistent with prior law, business meals provided to internal employees (e.g., employee travel meals and employee working meals) are 50% deductible under the Act.
Under prior law, a 50% deduction was allowed for expenditures incurred in connection with client business meals provided that the taxpayer was present and such meals were not lavish or extravagant. Pursuant to the new law, client business meals that meet the same requirements noted above are still 50% deductible.
The AICPA takes the position that business meals that (1) take place between a business owner or employee and a current or prospective client; (2) are not lavish or extravagant under the circumstances; and (3) where the taxpayer has a reasonable expectation of deriving income or other specific trade or business benefit from the encounter, are not disallowed. In a letter to the IRS dated April 2, 2018, the AICPA requested that the IRS provide immediate guidance on the change and recommended that the IRS confirm that business meals that meet the above criteria are deductible. Further guidance should be coming out from the IRS on this topic.