When Congress enacted the Tax Cuts and Jobs Act (TCJA) in December 2017, it had to make difficult trade-offs. Popular deductions had to be sacrificed to lower tax rates, and the lawmakers were concerned with the distributional effects. The changes could not primarily favor high-income taxpayers over lower-income taxpayers. Restricting the meals and entertainment (M&E) deduction is a product of those trade-offs. The new tax law all but abolishes the deduction for entertainment but keeps the deduction for business meals, with new restrictions. Let’s look at the details of these changes.
The new law repeals the deduction for business entertainment expenses, effective after December 31, 2017, except for:
- Employee events, such as office parties. The deduction is allowed for recreational, social or similar activities primarily for the benefit of rank and file employees rather than highly compensated employees.
That makes these types of expenses no longer deductible:
- Business entertainment at a social club, golf club, etc. including dues and use fees.
- Tickets to cultural events, such as theater, opera, etc.
- Outdoor activities, such as hunting, fishing and sailing outings
- Sporting events tickets, including ticket costs, skybox expenses and transportation to the event
- Contributions to educational organizations for the right to purchase tickets to athletic events. Previously, these payments were deducted as charitable contributions, but they are no longer deductible.
Business Meal Deductions Cut Back
Business meals are still deductible, but the allowable percentage has changed for some categories of business meals. Prior to 2018, a taxpayer could deduct 100% of meals provided to employees in employer-operated eating facilities. The new law reduces the deduction to 50% and repeals it completely in 2026.
For other business meals and meals eaten at entertainment facilities and events, the tax legislation is unclear. If business is conducted during the meal or shortly before or after, a 50% deduction may be available; however, the new law is unclear on the issue and taxpayers may have to await IRS guidance to get a definitive answer.
It appears that taxpayers can still deduct 50% of business-related meals with clients and business associates as long as business is conducted, the taxpayer is present and the meals are not lavish or extravagant. The 50% deduction also continues to be allowed for:
- Cost of meals incurred during business travel
- Transportation to and from business meals
- Meals during stockholder, director or employee meetings
- Meals at conferences and business league meetings
- Meals included in charitable sports packages
A 100% deduction is still available for:
- Expenses treated as employee compensation
- Reimbursed expenses
- Expenses for recreational, social or similar activities primarily for the benefit of employees
- Expenses for goods, services and facilities made available to the general public as paid entertainment
- Expenses for goods or services which are sold by the taxpayer in an arm’s length transaction
- Expenses includable in the income of persons who are not employees
Planning for New M&E Rules
To implement the new tax law’s changes to the M&E rules, companies will need to review their treatment of expenses and make sure they are categorizing each expense correctly. Going forward, it is important for companies to segregate the cost of entertainment activities from the cost of meals. In addition, it may be useful to set up different categories for entertainment (nondeductible), business meals (50% deductible), recreational/social employee expenses and compensation/reimbursed expenses (100% deductible) as separate ledger accounts to accurately track proper deductions.
There remains a lot of uncertainty about how the new restrictions will apply in different situations. Eventual guidance from the IRS should help taxpayers get definitive answers to some of the deductibility issues for M&E expenses going forward.