Prior to the passing of the Tax Cuts and Jobs Act (TCJA), meals and entertainment expenses were required to be evaluated under Code Section 274 to determine if the expense was 100-percent or 50-percent deductible. This is largely based on two tests: the directly related test and the associated test.
In other words, the question that must be answered is “is the expense directly related to or associated with the active conduct of an ordinary business function?” Answering no to this question generally would disallow a deduction for the related expense.
With the passing of TCJA (effective Jan. 1, 2018), the disallowances (whether 100-percent or 50-percent disallowed) apply more broadly to meals and entertainment, with entertainment generally being 100-percent disallowed (irrespective of the above two tests).
There are nine exceptions to this rule, however, as listed below:
- Food and beverage on employer premises.
- Personal entertainment treated as employee compensation on the employee’s W-2.
- Reimbursed expenses.
- Social and recreational activities for employees.
- Business meeting of employees, stockholders, directors, etc.
- Code Sec. 501(c)(6) business league meetings (e.g., chamber of commerce, real estate board, etc).
- Items available to the public (e.g., samples, public radio, etc).
- Entertainment sold directly to customers (e.g., mariachi band playing for customers of a restaurant).
- Items included in income of non-employee independent contractors.
If a taxpayer’s expense does not meet one of these exceptions, then the entertainment expense is 100-percent disallowed if the expense is incurred on or after Jan. 1, 2018.
This begs the question – What is entertainment?
– after the passing of tax reform.
Treasury Regulation Section 1.274-10 is the source for answering this question. It states that entertainment is “An activity of a type generally considered to constitute entertainment, amusement, or recreation…”
Not very helpful, right?
There are copious tax court cases, however, that get at the heart of this very issue. Also, it is important to note that the taxpayer’s business and perspective matters in making this determination.
For example, a non-sports fan attending the Super Bowl might not consider it to be entertainment. Also, a professional theater critic could not argue that attending a theatrical performance is an entertainment expense. Note that in the last example, although it wouldn’t be considered entertainment, it may be allowable as an ordinary and necessary business expense under Code Section 162.
A few examples of the tax treatment of certain meals and entertainment expenses incurred after 1/1/2018 are:
- Coffee and other drinks provided in the break room – 50-percent deductible. However, if part of a non-discriminatory employee social or recreational activity, then 100-percent deductible.
- Meals while on business travel – 50-percent deductible, generally. However, if entertainment, then “0” deduction, unless the entertainment is for non-discriminatory employee social or recreation activities, in which case 100-percent deductible.
- Air travel expenses to join business associates at a golf or other entertainment event – “0” deduction, generally. However, if with respect to either non-discriminatory employee social or recreation activities, or employee, stockholder, etc. business meetings, then 100-percent deductible.
- Evening entertainment activities, including meals, during employee, stockholder, etc. business meetings – 50-percent deduction for meals, 100-percent deduction for non-meal entertainment.
- Client or customer restaurant meals – “0” deduction where classified as entertainment. If not entertainment (e.g., meal following a family funeral), then 50-percent deduction.
In conclusion, the deductions for meals and entertainment expenses will be more severely limited than in the pre-2018 tax regime. It will be important for taxpayers to categorize their expenses in more detail and appropriately split expenses between meals and entertainment.
Just as important will be getting detailed invoices for packaged services (i.e., break out for meals, drinks, etc). Doing so will require enhanced bookkeeping and record keeping functions.
Discuss these expenses with your CPA ahead of time to determine the correct book and tax treatment.
Adam Shay, CPA (NC License Number 35961), MBA, is managing partner of Adam Shay CPA, PLLC. Over the last several years, the firm has grown from a one-man shop to one of the largest firms in the Wilmington area. Adam focuses on minimizing taxes and improving the financial results of entrepreneurs. Those results are obtained by taking a proactive approach to all aspects of taxes and financials. Adam is actively involved in supporting the Wilmington entrepreneurial and startup community. He earned a Bachelor of Business Science in commerce from the University of Virginia and a Master of Business Administration (MBA) degree from the University of Maryland. During his spare time, Adam enjoys spending time with his two boys and wife, Sarah, as well as coaching and watching sports and spending time outdoors.