The Tax Cuts and Jobs Act (TCJA) has made the typical business meal with clients and prospects non-deductible, and the deduction for most meals provided for employees is limited to 50% of the cost.
What did the Tax Cuts and Jobs Act change?
There were two big changes to the rules that allow a deduction for meals and entertainment.
- Meals provided to employees on the employer’s business premises that were previously 100% deductible are subject to the 50% deduction limit, and
- No deduction is allowed for any entertainment expenses
How does repealing the entertainment expense deduction affect meals?
The short answer is that, under the law, meals are considered entertainment. The 1986 Tax Reform Act said that any meal with a client or prospect is considered entertainment, and subject to all the same rules limiting deductions. In re-writing the law to eliminate the deduction for entertainment they also removed the law that permitted a deduction for business meals. In summary:
- The TCJA eliminates the tax deduction for activities considered to be entertainment, amusement, or recreation,
- Business meals with clients and prospects are considered to be entertainment,
- Therefore, no deduction for business meals with clients and prospects is permitted
Meals provided to employees (subject to the applicable deduction limitation) were not included in the business entertainment definition. Employee meals remain deductible subject to the 50% limitation, but in many cases exceptions apply to permit a full deduction.
Did Congress make a mistake?
Veena Murthy, legislation counsel for the congressional Joint Committee on Taxation, has commented that there is a difference between meals that are entertainment and meals that are not entertainment. In her remarks she also acknowledged that it isn’t clear from the law or the committee reports how taxpayers should determine which meals are entertainment.
There are a number of other “drafting errors” in the TCJA, including the definition of depreciable Qualified Improvement Property and the so-called “grain glitch”. However, it is not clear if a technical corrections bill will include changes to the meals deduction along with other fixes. Attempts to pass such a bill could also be delayed by negotiations over DACA, the Affordable Care Act, and gun control legislation. The IRS does have significant authority to write regulations interpreting the law and establishing rules, but they cannot implement anything that contradicts the law.
It is likely that Congress did not intend to take away this deduction. And it is possible that this situation could be remedied by Congress or by the IRS. But for now the deduction for business and prospect meals has been eliminated, and taxpayers need to prepare for this as they record the information that will be used to prepare 2018 tax returns.
What should you do?
Taxpayers need to comply with this law starting in 2018, but be aware that this could be changed by congress or by IRS guidance. We think the best thing to do is to use the following categories to track your meals and entertainment spending. Consider setting up these categories in your general ledger to simplify year-end reporting:
- Entertainment – 0% deductible: This would include golf, skiing, tickets to sporting events or concerts, and any other entertainment spending that has a business connection. This is non-deductible under the new law and is unlikely to be changed.
- Entertainment Meals – 0% deductible: Use this category to record client and prospect meals that are currently non-deductible, but may be retroactively changed to permit a 50% deduction.
- Non-entertainment Meals – possibly 50% deductible (See below)
- Meals – 50%: provided to employees occasionally or provided for the convenience of the employer.
- Meals – 100%: Include company outings, holiday parties, etc., that are equally available for the benefit of all employees.
We can hope that Congress or the IRS will clarify if they will continue to allow the deduction for business meals. But until they issue guidance taxpayers can rely on we recommend that businesses account for meals expenses using the categories above.
Can you deduct Non-Entertainment Meals?
The final thing taxpayers should consider is if they feel confident that their business has non-entertainment customer meals. There is currently no official guidance on how to make this determination. But Venna Murthy’s comments may be telegraphing congress’s position with respect to business meals, and it could be that Congress has created, or soon will create, a new category of non-entertainment meals. Taxpayers must make the best attempt to interpret the new law.
- Conservative taxpayers may take the position that all of their client & prospect meals are non-deductible, and may later want to file amended returns if subsequent guidance supports a different position.
- Other taxpayers may want to take the return position that they have business meals that should be deductible. Those taxpayers should be prepared to explain why their business meal expense is not entertainment related. It may also be advisable to include a disclosure statement with their tax return to avoid penalties that could be assessed in the event the IRS finds their position to be unreasonable.