The Tax Cuts and Jobs Act (TCJA) initially seemed to eliminate the popular meal expense deduction for businesses in some situations. The IRS has since issued transitional guidance — while it works on proposed regulations — that confirms the deduction remains allowable in certain circumstances and clarifies when businesses can claim it.

The need for guidance

Before the TCJA, the tax code generally prohibited deductions for expenses related to entertainment, amusement or recreation (commonly referred to as entertainment expenses). It provided exceptions, though, for entertainment expenses “directly related” to or “associated” with conducting business.

The code further limited deductions for food and beverage expenses that satisfied one of the exceptions. A deduction was allowed only if 1) the expense was not lavish or extravagant under the circumstances, and 2) the taxpayer (or an employee of the taxpayer) was present when the food or beverages were furnished. The amount of the deduction was limited to 50%.

Tax reform revised the tax code to disallow a deduction for expenses related to entertainment expenses, regardless of whether they are directly related to or associated with conducting business. Some taxpayers interpreted the amendment to ban deductions for business meal expenses as though they were deemed to be entertainment expenses. According to the new guidance, though, the law does not specifically eliminate all of these expenses.

Rather, the law merely repeals the two exceptions and amends the 50% limitation to remove the reference to entertainment expenses. The TCJA does not address the circumstances in which providing food and beverages might constitute nondeductible entertainment, the IRS says, but its legislative history “clarifies that taxpayers generally may continue to deduct 50% of the food and beverage expenses associated with operating their trade or business.”

Deductibility requirements

Until the IRS publishes its proposed regulations explaining when business meal expenses are nondeductible entertainment expenses and when they are 50% deductible expenses, businesses may deduct 50% of business meal amounts if:

  1. The expenses are ordinary and necessary expenditures paid or incurred to carry on business,
  2. The expenses are not lavish or extravagant under the circumstances,
  3. The taxpayer (or an employee of the taxpayer) is present at the furnishing of the food or beverages,
  4. The food and beverages are provided to current or potential customers, clients, consultants or similar business contacts, and
  5. For food and beverages provided during or at an entertainment activity, the entertainment is purchased separately from the food and beverages or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts.

The IRS recognized that the fifth criterion above could create some confusion. The guidance, therefore, includes illustrative examples.

In the first example, a taxpayer invites a business contact to a baseball game, paying for both tickets. While at the game, the taxpayer also pays for hot dogs and drinks. The game is entertainment, so the cost of the tickets is a nondeductible entertainment expense. However, the cost of the hot dogs and drinks, purchased separately from the tickets, isn’t an entertainment expense. Therefore, the taxpayer can deduct 50% of the cost as a meal expense.

The second example employs a similar scenario, with the taxpayer inviting a contact to a basketball game. This time, though, the taxpayer buys tickets to watch the game from a suite, with access to food and beverages included. The game again represents entertainment, and the cost of the tickets is nondeductible. The cost of the food and beverages is not stated separately on the invoice, rendering it a disallowed entertainment expense, as well.

The final example uses the scenario above, except that the cost of the food and beverages is stated separately on the invoice for the basketball game tickets. The cost of the tickets remains nondeductible, but the taxpayer can deduct 50% of the cost of the food and beverages.

Nondeductible entertainment

TCJA does not change the definition of “entertainment.” Under the applicable regulations, the term continues to include, for example, entertaining at:

Entertainment also includes hunting, fishing, vacation and similar trips. It may include providing food and beverages, a hotel suite or an automobile to a customer or the customer’s family.

Be aware that the determination of whether an activity is entertainment considers the taxpayer’s business. For example, a ticket to a play normally would be deemed entertainment. If the taxpayer is a theater critic, however, it would not. Similarly, a fashion show would not be considered entertainment if conducted by an apparel manufacturer to introduce its new clothing line to a group of store buyers.

Request for comments

The IRS has requested comments on future guidance clarifying the treatment of business meal expenses and entertainment expenses, including input on whether and what additional guidance is required and the definition of “entertainment.” Businesses should submit comments to the IRS by December 2, 2018. If you have questions on how this guidance may affect your business, contact your tax professional.

If your business claims deductions for meal, entertainment, vehicle or travel expenses, be aware that the IRS may closely review them. Too often, taxpayers don’t have the necessary documentation to meet the strict requirements set forth under tax law and by the IRS.

Be able to withstand a challenge

Whether you file a business return or file Schedule C with your personal return, these deductions can be a hot button for the IRS. Here are some DOs and DON’Ts:

DO keep detailed, accurate records. Documentation is critical when it comes to deducting meal, entertainment, vehicle and travel expenses. You generally must have receipts, canceled checks or bills that show amounts and dates. In addition, there are other rules for specific expenses. For example, you must record the business purpose of entertainment expenses, as well as the names of those you entertained and their business relationship to you. If you reimburse employees for expenses, make sure they comply with the rules.

DON’T re-create expense logs at year end or wait until you receive an IRS deficiency notice. Take a moment to record the details in a log or diary at the time of the event or soon after. Require employees to submit monthly expense reports.

DO keep in mind that there’s no “right” way to keep records. The IRS website states: “You may choose any recordkeeping system suited to your business that clearly shows your income and expenses.”

DO respect the fine line between personal and business expenses. Be careful about trying to combine business and pleasure. For example, you can’t deduct expenses for a spouse on a business trip unless he or she is employed by the company and there’s a bona fide business reason for his or her presence.

We can help

These are general rules and there may be exceptions. If your records are lost due to, say, a fire, theft or flood, there may be a way to estimate expenses. With guidance from us, you can maintain records that can stand up to IRS scrutiny. For more information about recordkeeping, contact us.