True Alert: The cost of business development just became more expensive…
This True Alert highlights key aspects of the tax law changes resulting from the Tax Cuts and Jobs Act (“TCJA”) regarding business deductions for Meals & Entertainment (“M&E”).
The cost of business development just became more expensive. Companies that entertain prospective or existing customers, as well as employees, are living in a new world when it comes to deducting those expenses for federal tax purposes. The following True Alert explains certain critical information for businesses looking to update their internal policies, maximize their tax deductions for future expenditures, and ensure proper compliance under the new law post TCJA.
Entertainment Expenses No Longer Deductible
Prior to the TCJA, entertainment expenses were generally nondeductible under Internal Revenue Code (the “Code”) § 274(a)(1), except for 50% of certain entertainment costs considered “ordinary and necessary” and were either: (i) directly related to the taxpayers trade or business (the “directly related” exception); or (ii) provided either immediately before or after a bona fide business discussion (the “business discussion” exception).
TCJA changed the landscape for deducting entertainment expenses by repealing both exceptions. As a result, entertainment costs incurred after December 31, 2017 are nondeductible.
TCJA also eliminated tax deductions for dues and subscriptions paid to clubs organized for a valid business purpose. Additionally, most amounts paid for qualifying meals are now subject to the 50% limitation of Code § 274(n)(1). Before TCJA, these meal costs were fully deductible if the amount was includible in the recipient’s gross income (e.g. de minimis fringe benefits per Code § 132). Further, the law – barring any further amendments by Congress – will completely disallow deductions for meals provided to employees for the employer’s convenience after December 31, 2025.
The Internal Revenue Service issued Notice 2018-76 (the “Notice”) stating their intention to issue proposed regulations on the rule changes for M&E. Meanwhile, the Notice provides some preliminary guidance to taxpayers about how to determine which of their M&E expenses are nondeductible and which are eligible for a 50% deduction.
The Notice echoes Code § 274(k), allowing a 50% deduction for “ordinary and necessary” business meals that: (i) are not extravagant or lavish, (ii) during which the taxpayer (or its employee) is present at the furnishing of the meal, and (iii) which is being provided to a current or potential client or business contact. The Notice further clarifies that business meals are still 50% deductible when provided in conjunction with entertainment, but only if (1) the meal is separately stated on the bill from the cost of the entertainment, and (2) the entertainment disallowance rule is not circumvented by inflating the amount paid for meals.
Other Changes to Code § 274
Other elements of Code § 274 have also been removed or amended. For example, the guidelines addressing “Additional Limitations on Entertainment Tickets” have been replaced with guidelines for “Transportation And Commuting Benefits,” which bar the deduction for expenses incurred to reimburse or pay for an employee’s travel between his or her place of residence and work, unless it is for the employee’s safety (e.g. costs paid for employee parking, including parking lots and garages). Additionally, qualified transportation fringe benefits are no longer deductible and the definition of items considered “tangible personal property” described under “Employee Achievement Awards” were added; “tangible person property” now excludes items such as “cash, gift cards…or vacations, meals… tickets… securities, and other similar items.”
Taxpayers can no longer assume that all meals and entertainment expenses are 50% deductible. Beginning in (calendar year) 2018, and for fiscal year filers with meals incurred after December 31, 2017, tax departments will need to request additional data (e.g. detailed invoice breakdown, further documentation around parties present, intent of events, additional breakdown requested by A/P regarding invoices prior to payment) from their finance and accounting functions in order to determine the deductibility of M&E expenditures. This will require most companies to change their internal policies and documentation standards for M&E expenses.
Is your tax department prepared for the tax law change?
Has your company started implementing new firm-wide documentation standards for M&E expenditures?
Have you determined how your tax team will identify which meals and entertainment expenses are deductible/nondeductible?
Has your accounts payable function ensured the invoices received provide sufficient data to achieve the desired tax benefits?
Has your organization considered using an acceptable statistical sampling approach to support items on your income tax returns?
TPC can help you navigate this new landscape through data analytics and technical analysis.
The team at True Partners Consulting offers a combination of highly experienced tax advisors who can help your company adopt the new rules for M&E deductions as well as other tax law changes that resulted from TCJA. We are prepared to work closely with clients to identify opportunities and to develop successful strategies to avoid the inevitable pitfalls that come with implementing various aspects of tax reform.
Please contact Jim Hedderman, James.Hedderman@TPCtax.com or Jason Carter, Jason.Carter@TPCtax.com.