The Tax Cuts and Jobs Act (TCJA) made sweeping changes to the tax system, with many provisions affecting small and large taxpayers alike. Once such change significantly modifies the deductibility of meals and entertainment expenses. The new tax law decreases the amount of allowable deductions as of January 1, 2018, and may require changes to how companies account for these expenses.
Under the former tax law, a deduction was allowed for 50 percent of entertainment expenses incurred if directly related or associated to the business. Under the TCJA, no entertainment deduction is allowed. This means any business expenses incurred for recreation or amusement can no longer be claimed, including for example, golf outings, sporting events, concerts, hunting and fishing trips, and country club dues.
Under the TCJA, business meals remain deductible for 50 percent of the expense. In order to be considered a business meal, it must be directly related or associated with the active conduct of the taxpayer’s business. Directly related means a concrete business benefit is expected to be derived (a sale or immediate revenue), not just general goodwill from a client. A meal is associated with the business if it precedes or follows a substantial and bona fide business discussion/meeting; if this is the case, the meal will qualify if the purpose is to get new business or encourage the continuation of a business relationship.
It is important to note that although entertainment expenses are disallowed, the food and beverages consumed during entertainment activities can be broken out and may be deductible as business meals if it can be proven that business was conducted. However, if a meal is determined to be part of an entertainment expense, then such meal would not be deductible. The burden of proof is on the taxpayer to establish that a business meal is not an entertainment expense.
The former law permitted certain meals to be fully deductible if provided either in a company cafeteria or on the employer’s premises if for the convenience of the employer. Under the TCJA, all employee meals are subject to a 50 percent deduction. This applies to meals served to employees in a company cafeteria, meals provided for the convenience of the employer, employee meals while traveling, meals for company meetings, and meals provided to employees as fringe benefits such as meals provided to enable an employee to work overtime. After 2025, expenses for meals provided in company cafeterias and for the convenience of the employer are entirely disallowed.
The current law contains a carve-out that permits a full 100 percent deduction for expenses associated with recreation or social activities primarily for the benefit of employees, including holiday parties and employee gym facilities. This was not changed by the TCJA.
Another way taxpayers can deduct 100 percent of meal expenses is to include employee meals in employees’ compensation. Note, however, that employees will not be able to deduct the cost on their personal return and will have to pay tax on the associated income.
Now is a good time for taxpayers to review their current accounting, reimbursement, and employee meal policies, as well as their documentation procedures for meals. Documentation must establish the amount, time, place, business purpose, and business relationship of those present (identify the who, what, where, when and why). It should also clearly state how much of the expense relates to entertainment and how much relates to food/beverage.
Taxpayers should consider creating separate general ledger accounts for entertainment, meals, and employee holiday parties in order to have the expenses correctly categorized at year-end for tax preparation. Taking the time to accurately record expenses as meals or entertainment throughout the year will help ensure that all eligible amounts are captured for deduction.