Is a meal with an employee or a customer considered “entertainment” or a “business meal?” Should it make a difference? Provisions within the Tax Cuts and Jobs Act enacted in December have raised an issue for which a clear answer to this question does not currently exist, and it could have a material economic impact on businesses.
For the person picking up the check, the resolution of this issue will determine whether a tax deduction will be available. For the owner of the restaurant or other facility where the event takes place, it could lead to changes in customer behavior; i.e., a decline in business that was historically driven, in some part, by the ability for patrons to claim a tax deduction.
Under prior law, the Internal Revenue Code restricted tax deductions for meals and entertainment costs to 50 percent of the expense incurred. Meals provided to employees for the convenience of an employer and certain other de minimis fringe benefit circumstances were 100 percent deductible.
Effective January 1, 2018, no tax deduction will be permitted for entertainment costs and meal costs previously fully deductible under the “for the convenience of the employer” criteria will now be subject to a 50 percent deduction limitation. Tax deductions for certain costs may not be impacted by the changes in the tax code. For example, a common interpretation of the new law suggests that the cost of an employer holiday party should continue to be fully deductible.
Note that the terminology used with respect to the prior law regarding the 50 percent category stated “meals and entertainment.” A distinction between the two may be easy to make in certain settings. Taking a client to dinner involves a “meal” while taking a client out to a baseball game involves “entertainment.” The context becomes a bit blurred when both a meal and entertainment occur during the same client interaction; for example, a meal provided while at the baseball game.
Such a distinction did not matter under the prior law, since both types of activities were subject to the 50 percent deduction limitation. You could argue that purposely separating “meals” and “entertainment” is a bit absurd given the overriding goal of the activity – to create an environment in which you can discuss the continuation or expansion of business activities with a customer. From that perspective, both activities are as justifiable as any other business expense.
The Federal tax code is not necessarily based upon a foundation of logic, but rather, of statutory license. Some business activities have historically been viewed with greater suspicion than others, and meals and entertainment activities have both been identified in the tax code as having potential for abuse or inappropriate personal benefit that should be restricted in a tax deduction subsidy. Past restrictions on deductions have not made a distinction between meals and entertainment outside of the context of a meal provided provided to an employee for the convenience of an employer or other de minimis fringe benefit circumstances.
The Tax Cuts and Jobs Act potentially changes this going forward by placing greater restriction on pure entertainment activities while potentially preserving a 50 percent deduction for some meal-related activities.
The current thinking of many tax advisors is that a 50 percent deduction should continue to be available for a meal with a current or prospective customer at a restaurant (as opposed to an entertainment venue), provided it is reasonable in nature and the taxpayer can establish an expectation of deriving a business benefit. A similar outcome should arise when an employer incurs an expense involving a meal with an employee for which a comparable expectation of business benefit exists. Such circumstances should not be viewed as “entertainment,” for which no tax deductions will be allowed going forward.
At some point, the IRS will issue proposed regulations that will clarify its interpretation of the change in law. If history is any indication, many taxpayers and their advisors may assert that these proposed regulations are unreasonable in some respects, leading to a period of comment, review, and possible revision. However, it is likely that this regulatory project will not be high on the list of the IRS’s priorities as it attempts to come to grips with the massive overhaul of our tax system.
Taxpayers should continue to track meal-related costs with an appropriate level of documentation to support any position taken with regard to a tax deduction. The first line of argument by an IRS examiner in challenging meal and entertainment deductions has typically focused on a failure to establish the existence of appropriate elements of business relationship, and this may take on an even greater significance in the future.
We will be happy to answer questions relating to specific types of activities and related costs.
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