The two-martini lunch. You’ve probably heard the phrase. Maybe even three-martini.
At a time in the not-too-distant past, business was typically conducted over drinks, and possibly food. Often with entertainment, maybe a sporting event. The IRS even supported the approach with a tax deduction for business-related meals and entertainment.
Now, not so much.
With tax reform, beginning January 1 of 2018, changes to the federal tax code significantly limit such deductions on the part of businesses.
Let’s start with two critical definitions: meals and entertainment.
Meals This one’s pretty simple, food and beverages. Examples include breakfast, brunch, lunch, dinner and snacks.
Entertainment This definition is a bit more complicated. For tax purposes, entertainment has been loosely defined to include any item related to an activity generally considered to provide entertainment, amusement, or recreation, and often includes food and/or drink.
So here’s where the confusion comes in. When entertainment includes food and/or drink — say, you’re taking a client golfing or to a sporting event in your company’s skybox, with lunch provided — is that food and drink considered an element of the entertainment for tax purposes or, alternatively, a meal?
Before 2018, the answer to that question didn’t matter. The tax deductibility of both meals and entertainment was essentially the same. Provisions in the Tax Cuts and Jobs Act changed that parity after 2017.
Now, the deductibility of a food/drink expenditure depends on the whether it is considered a meal or part of an entertainment for tax purposes, and the IRS has yet to provide guidance.
Requirements for a Tax Deduction
Before any other consideration, to be deductible a meal or entertainment expenditure must be related to, or associated with, the active conduct of a trade or business. It cannot be considered extravagant, in which case only the ordinary (non-luxury) element is deductible.
The tax treatment of such business expenditures for meals and entertainment is as follows:
|Meals with business associates, including clients/customers, prospective clients/customers, referral sources, centers of influence, industry luminaries and colleagues||50%||No change|
|Entertainment (including those that include meals) with business associates, including clients/customers, prospective clients/customers, referral sources and colleagues||0%||Previously 50%
The deductibility of any meal included with the entertainment has not been established. IRS guidance is pending.
|Clarifications and Exceptions|
|Meals for employees while traveling on business||50%||No change
Employee’s duties must require travel away from their tax home and include an overnight stay
|Meals and entertainment necessary for attendance at a convention/meeting of a chamber of commerce, business league or other 501(c)(6) organization||50%||Previously: 100% entertainment, 50% meals|
|Meals and entertainment in connection with business meetings of shareholders, employees, directors and agents||50%||No change|
|Employee meals provided in company cafeteria or similar facility||50%||Previously 100%
0% deductible after 2025
Deductibility of related operating costs after 2025 is uncertain
|Employee meals for the convenience of the employer||50%||Previously 100%
0% deductible after 2025
|Meals considered a de minimis fringe benefit (excludable from employee’s income) such as coffee and pastry and overtime or working meals||50%||Previously 100%
0% deductible after 2025
|Entertainment expenses that are reimbursed according to an expense allowance or other reimbursement arrangement||100%||No change
Must document a breakdown of expenses
|Meals and entertainment expenses paid by company and considered taxable compensation to employee||100%||No change
Must also be considered wages for purposes of tax withholding
|Holiday parties, company picnics and other events and recreational activities provided for the benefit of employees||100%||No change
Deduction for employee portion only; any customer or outsider portion is not deductible
Event must be generally available to employees and not targeting highly compensated employees
|Meals and entertainment expenses included in the income of a non-employee||100%||No change
Must be reported as income by recipient
Considerations for Implementing the Revised Rules
Without specific guidance from the IRS, a strict reading of the new law indicates meals included with entertainment are not deductible. However, many experts believe Congress did not intend to eliminate the deductibility of such meals.
Until the IRS provides additional guidance, the best approach might be to separately track the cost of meal and entertainment components. That way, if the guidance indicates these meals are deductible, you have the requisite information to claim them on your tax return.
Depending on your existing accounting procedures and software, such separate tracking may require changes. If this type of change is a burden or an impossibility, the IRS may allow you to use statistical sampling to separate deductible and nondeductible expenses — as long as you follow its guidelines.
Wondering about the impact of tax reform?