WHICH MEAL AND ENTERTAINMENT EXPENSES ARE STILL DEDUCTIBLE UNDER THE TCJA?
The Tax Cuts and Jobs Act (TCJA; P.L. 115-97, 12/22/2017) made major changes to one of the more common business expenses—outlays for meal and entertainment. As explained below, many, but not all, entertainment expenses are no longer deductible after 2017. A number of meal expenses also escape the crackdown, although questions remain about the deductibility of the most common type of meal expense—for "business meals" where a substantial and bona fide business discussion takes place during the event. The following discussion—reviews the TCJA changes and explores whether a "business meal" remains deductible under the TCJA.
Overview of the Meal and Entertainment Rules
Under pre-TCJA law, no deduction was allowed for ordinary and necessary expenses for an activity of a type generally considered to be entertainment, amusement, or recreation, or for a facility used in connection with such an activity, unless the taxpayer established that the expense was directly related to, or, in the case of an item directly preceding or following a substantial and bona fide business discussion, associated with the active conduct of the taxpayer's trade or business or income-producing activity.
In practical terms, meal expenses were treated as a subset of entertainment expenses and under the Tax Reform Act of 1986 ('86 TRA), were subject to the "directly related to" or "associated with" business requirements. (Com. Rpt. to the '86 TRA, PL 99-514, 10/22/86, General Explanation of the Tax Reform Act of 1986, JCS -10-87, May 4, 1987, pp. 68-70).
The deduction for meal and entertainment expenses was limited to 50% of the otherwise deductible amount of the expense. (Former Code Sec. 274(n)(1)).
Effective for amounts paid or incurred after Dec. 31, 2017, the TCJA repeals the rule that allowed a deduction for entertainment, amusement, or recreation expenses that were directly related to or associated with the active conduct of the taxpayer's trade or business. Instead, as a general rule, the Code provides that an otherwise allowable deduction can't be claimed for an activity which is of a type generally considered to constitute entertainment, amusement or recreation, or with respect to a facility used in connected with such an activity. (Code Sec. 274(a)(1)(A)) Thus, the bar on deductions applies to the cost of tickets to sporting events, stadium license fees, private boxes at sporting events, theater tickets, golf club dues, etc.
The TJCA also provides, generally, that only 50% of otherwise allowable expenses for meals—food and beverages—are allowable as a deduction. (Code Sec. 274(n)(1))
After signing up a major client, an attorney takes the client to a nightclub, or to a sporting event. Under prior law, this was deductible as entertainment "associated with" the active conduct of a trade or business (if adequate records of the event were kept) and 50% of the cost was deductible. Under the TCJA, there is no deduction for the cost of such entertainment.
As added by the '86 TRA, a meal expense is not deductible unless:
The expense is not lavish and extravagant under the circumstances, and
The taxpayer (or an employee of the taxpayer) is present at the furnishing of such food or beverages. (Code Sec. 274(k))
These additional requirements for meals weren't changed by the TCJA.
Is a "Business Meal" Deductible under the TCJA?
The TCJA does not explain the tax treatment of an expense commonly described as a "business meal". For example, a substantial and bona fide business discussion, such as a strategy session attended by the leaders of a business unit, or a business meeting between a business person and a client, takes place during lunch or dinner at a restaurant. Or the discussion may begin at the office and continue over a meal at a restaurant.
Under pre-TCJA regs, such a meal was treated as "directly related" to the active conduct of a trade or business if, in general, the main purpose of the event was the active conduct of business, the taxpayer had more than a general expectation of deriving income, or another specific benefit, from the meal, and the taxpayer did, in fact, actively engage in a business meeting, negotiation, discussion,or transaction during the meal. (Reg. § 1.274-2(c)(3)) The cost of such a meal was 50% deductible if the Code Sec. 274(k) requirements were met, and the expense was substantiated (generally, time, place, amount and business purpose).
The TCJA keeps intact Code Sec. 274(k)—captioned "business meals"—which carries additional requirements that apply to meals only, including the unique requirement that the taxpayer (or his agent) be present at the meal, implying that a "business meal" such as the ones we've described above, might continue to be 50% deductible. But the TCJA abolishes the "directly related to" or "associated with" standards that used to apply to business meals and entertainment, so it's not clear what requirements a "business meal" would have to meet in order to be deductible, other than the Code Sec. 162(a) ordinary and necessary business expense standard.
The committee report to the TCJA doesn't shed much light on this question, other than to declare that "Taxpayers may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel)".
This issue, which IRS hopefully will address soon, has immediate and ongoing tax implications not only for self employed individuals who have business meals, but also for the many employers who require employees to engage in "business meals", and for the employees themselves.
Under long-standing regs, an employee expense that's reimbursed by the employer is treated as made under an accountable plan only if (among other conditions) it meets a business connection requirement.
Under this requirement, the expense must be made for an otherwise deductible business expense that is paid or incurred by an employee in connection with performing services as an employee of the employer. (Reg. § 1.62-2(d)) Amounts reimbursed under an accountable plan are tax-free to the employee. The employer, on the other hand, deducts the reimbursement, subject to whatever deduction restrictions apply to the underlying expense (e.g., 50% deduction limit on meals).
If the business connection requirement isn't met, the expense is automatically treated as made under a nonaccountable plan. (Reg. § 1.62-2(c)(3)) The amount of the expenditure must be treated as wages to the employee, subject to payroll- and income-tax withholding when paid. The employer deducts the reimbursement amount as compensation (assuming total compensation paid to the employee is "reasonable").
Under the Code Sec. 274 rules as revised by the TCJA, the employer's deduction for an amount paid that's treated as compensation to the employee—e.g., an amount paid under a nonaccountable plan—isn't subject to the general Code Sec. 274(a) disallowance rule, the Code Sec. 274(k) special requirements for business meals, or the Code Sec. 274(n) 50% deduction limit on meals. (Code Sec. 274(e)(2)(A), Code Sec. 274(k)(2)(A), Code Sec. 274(n)(2)(A))
An employee takes a client to a "business meal" to discuss a pending sale and pays the bill via a company provided credit card. He timely substantiates the expense in full to his employer (time, place, amount, business purposes, plus receipts). If the event took place in 2017, the entire reimbursement was treated as made under an accountable plan and was tax-free to the employee. The employer deducted 50% of the cost.
The results would remain the same if the event takes place in 2018 and IRS relies on the committee report statement to continue to treat the expense as 50% deductible under Code Sec. 162 and Code Sec. 274. If the expense is treated as nondeductible, however, then the 2018 expense would be treated as paid under a nonaccountable plan. That means it would be included in the employee's wages and would be subject to payroll- and income-tax withholding. The employer, on the other hand, would deduct the meal expense in full.
The situation of an independent contractor who pays for a "business meal" on behalf of a client in 2018 would roughly parallel the employee's "business meal" on behalf of an employer.
If the "business meal" is still a deductible expense, an independent contractor who accounts in full for the expense to his client would not be subject to any of the Code Sec. 274(a) limitations. (Code Sec. 274(e)(3), Code Sec. 274(k)(2)(A), Code Sec. 274(n)(2)(A)). The client, on the other hand, would be subject to the Code Sec. 274 limitations, such as the 50% disallowance for meal expenses. If the "business meal" is not deducible under Code Sec. 274(a)(1), then the expense would have to be reported on Form 1099 and the amount of the expense would be deductible in full by the client. (See Reg § 1.274-2(f)(2))