Entertainment Expense Reimbursements = Taxable Wages in Existing Regulation
Articles by: Richey May, Jun 28, 2018
June 2018 – The Tax Cuts & Jobs Act (TCJA) eliminated the deduction for business entertainment expenses incurred after December 31, 2017. While this rule may sound fairly straightforward, there is currently a potentially significant tax difference between entertainment expenses that the company pays directly to third party vendors from the treatment of entertainment expense that it reimburses to its employees. Those payments the company makes directly to vendors for entertainment will simply be nondeductible company expenditures. Absent modified IRS guidance to the contrary, current Treasury regulations imply that the reimbursements of entertainment expenses to employees should be reported as taxable wages on the employees’ W-2s. While this result appears to have been unintended since there were no specific law changes to the accountable plan rules for expense reimbursements, the IRS may or may not update existing regulations with new guidance to simply treat such reimbursements as nondeductible company expenses that are not taxable wages.
Taxable wage treatment and reporting is specified in the regulations governing accountable and nonaccountable expense reimbursement plans. These rules state that reimbursements of business expenses that are deductible by the company are not wages. In contrast, reimbursements of expenses that have a “business connection,” but are not deductible by the company, are deemed to be paid from a nonaccountable plan and reportable as taxable wages. There is an exception for the portion of meals expense that is nondeductible due to the 50% deduction limits. This provision also previously applied to the 50% nondeductible portion of entertainment prior to the new tax law. This specific exception no longer applies to entertainment since it is now fully nondeductible. Prior to the new law, reimbursement of nondeductible entertainment was already required to be included in taxable wages (i.e. for all business entertainment that did not satisfy the substantiation requirements required for a 50% deduction). Consequently, entertainment expense reimbursements that are properly reported as taxable wages are always deductible by the company as compensation expense.
There has been no change to the rules relating to the reimbursement of personal and other nonbusiness expenses that have no business connection under the regulations. These types of expenses should never be reimbursed under the company’s expense reimbursement plans. Doing so can result in taxable wage treatment of all expense reimbursements including those other reimbursements that would otherwise be substantiated business expenses excluded from wages.
Companies incurring business entertainment expenses should pay as much as possible directly to vendors. Another potential strategy companies may want to consider is issuing company paid credit cards to specific individuals rather than reimbursement arrangements that cover business entertainment. If this strategy is used, these should not be company credit cards that are issued to, and paid by, the individual since those are still reimbursement arrangements even if company paid on behalf of the individual. Without modified IRS guidance, our firm generally recommends minimizing reimbursements for entertainment and having the company pay as much as possible directly. Based upon the level of entertainment activities, companies that choose to treat reimbursements of business entertainment as nontaxable to the employee and nondeductible by the company need to fully understand the significance of potential penalties and late payroll tax deposits that may be required later if the IRS does not revise regulations with additional guidance.
Richey May’s tax professionals are available to answer any of your questions, or contact us.