Navigating Meals and Entertainment Deductions Post Tax Cuts and Jobs Act
Articles by: Richey May, Jun 04, 2020
Many taxpayers are incurring expenses related to meals and entertainment. These expenses include meals with customers, internal meals for employees, entertainment expenses, and other similar expenses. Additionally, many taxpayers think all these expenses are 50% deductible and no tax planning opportunities are available. However, taxpayers who have a basic understanding of the rules as well as internal policies that institute best practices for tracking and approving expenses, may find additional deductions in the area of meals and entertainment that could ultimately lead to a reduction in taxable income.
Taxpayers should note to deduct an expense for food and beverage it must meet two requirements. First, the expense must not be lavish or extravagant under the circumstances. Second, the taxpayer or an employee of the taxpayer must be present at the furnishing of the food or beverage. Additionally, taxpayers should note that the Tax Cuts and Jobs Act (TCJA) eliminated the deduction for entertainment expenses.
Food and Beverage Expenses
As a result of TCJA, most food and beverage expenses are now subject to the 50% limitation. For example, TCJA repealed the 100% deduction for de minimis food and beverage fringes and subjected these expenses to the 50% limit. These repealed de minimis expenses include coffee, soft drinks, snacks, eating facilities on or near the premises, etc. made available for employees.
While most food and beverage expenses are now subject to the 50% limitation, certain exceptions do exist which will allow a taxpayer to deduct the expense in full. These exceptions include:
- Expenses for goods, services, and facilities, to the extent that they are incurred are included in compensation to the recipient. This exception is available if the expense is deducted as compensation expense on the taxpayer’s originally filed return and is treated as wages to the employee for purposes of withholding. Additionally, this exception can be applied to independent contractors if the amount is included in a Form 1099 issued to the contractor (it should be noted the 1099 must be issued even if otherwise not required because the amounts are less than $600).
- Expenses incurred by a taxpayer in connection with the performance of services for an employer or other person under a reimbursement or other expense allowance arrangement. In this situation either the service recipient or the service provider will incur the 50% limitation burden, but not both.
- Expenses for recreational, social, or similar activities for employees. This exception relates to expenses paid or incurred for events such as holiday parties, annual picnics, or summer outings. However, it cannot be used as a work around for meals paid for the convenience of the employer (including break room supplies). Please note this exclusion only applies to food and beverage expenses primarily for the benefit of employees other than highly compensated employees, such as officers and shareholder or partners who on at least a 10% interest in the business. This does not mean that highly compensated employees cannot attend these functions but rather that the expenses cannot be exclusively for the benefit of these highly compensated individuals and must be made available to all employees.
- Expenses for goods, services, and facilities made available to the general public. This exception is still available even if the food or beverage is made available to employees of the employer, as long as the primary consumer of the food and beverage is the general public. In this case, a test of more than 50% consumption by the general public is used.
- Expenses for goods or services that are sold by the taxpayer in a bona fide transaction for adequate and full consideration in money or money’s worth. This exception applies to taxpayers who primarily engage in the selling of food and beverage as a part of their business such as a restaurant or bakery.
As mentioned previously, TCJA repealed the 50% limit for deducting entertainment expenses and made the expenses entirely nondeductible for tax purposes. Therefore, no deduction is allowed for 1) entertainment, amusement, or recreation expenditures, 2) expenditures related to a facility in relation to entertainment expenditures (i.e. dues or fees to any social, athletic, or sporting club organizations), or 3) expenses incurred for membership in clubs organized for business, pleasure, recreation or other social purpose. To make this determination, an objective test is used and considers the taxpayers trade or business. Therefore, if it is determined that the activity is generally considered to be entertainment, it will be treated as entertainment and become nondeductible even if the expense can be described otherwise.
Taxpayers should note that TCJA does distinguish between entertainment and food and beverage expenses. Food and beverage expenses are not considered entertainment unless they are provided during or at an entertainment activity. However, even if food and beverages are provided during an entertainment activity it is possible to escape the entertainment classification if the food and beverages are purchased separately from the entertainment or the cost is separately stated on one or more invoices. Therefore, if food and beverage expenses are purchased in connection with an entertainment activity, the taxpayer should request an itemized invoice that separately breaks out the entertainment expense and food and beverage expenses in order to properly classify and treat the tax deductions.
Once a basic understanding of the new rules is established, taxpayers can institute certain best practices to help maximize their tax deductions. First, taxpayers can create separate accounts to separately track nondeductible entertainment, 50% deductible meals, and 100% deductible meals. This will increase efficiencies when working with your tax preparer by reducing unnecessary follow up questions requesting a breakout of these expenses. Second, taxpayers can take advantage of the exceptions to the 50% limit for food and beverage expenses. Taxpayers should consider the benefit of the deduction while balancing relationships with employees and independent contractors and how those relationships may be affected by shifting the burden of the deduction to those individuals or including the amounts in taxable wages of the employee. Third, if entertainment expenses are incurred and include food and beverage expenses, taxpayers should request an itemized or separate invoice for the food and beverage expenses so that 50% of that expense can be deducted by the taxpayer. And lastly, in all instances taxpayer’s should have proper substantiation and records for deductions claimed.
In conclusion, TCJA eliminated deductions related to entertainment expenses and expanded the classification of food and beverage expenses subject to the 50% limitation. However, exceptions to the 50% rule for food and beverage expenses do exist that can allow a taxpayer to maximize their deductions in this area. Additionally, if proper documentation and receipts are available, food and beverage expenses in connection with entertainment expenditures can still be 50% deductible instead of entirely nondeductible. By following the best practices listed, taxpayers may find additional tax deductions that may otherwise have been limited.
For more information or help in updating your internal policies please contact the Richey May tax team.
You can see these changes in a tabular format in the PDF below.