Under the new tax law, business owners are no longer able to deduct the cost of entertaining an existing or potential client. Sporting event tickets – such as sky box tickets, charitable sports events or contributions to an education institution to purchase tickets for an athletic event – are non-deductible items. The same applies to entertaining clients at cocktail lounges, theaters, country clubs, on the golf course and more.
Entertainment-related meals are now non-deductible, and business meals appear to be 50% deductible. The distinction between an “entertainment meal” and a “business meal” is clearer when you are with a client at an entertainment venue that has a lot of distractions and where it is difficult to have a proper business discussion vs. lunch or dinner with a client where the purpose is to conduct business and the focus is not on entertainment. Further guidance from the IRS is needed to know for certain whether business-related meals will not be regarded as an entertainment meal and will remain 50% deductible.
There are some expenses that fall under the “entertainment” category that are eligible for a full deduction. Free promotional items given to the public qualify, as does the cost of entertainment services billed to customers (such as on a cruise ship or at a dinner theater).
Employee meals that were previously 100% deductible are now subject to a 50% limitation if they are:
- Provided on employer business premises for the convenience of the employer
- Occasionally provided to employees for weekend work or overtime
- Snacks and beverages provided to employees on business premises
Employee meals will be non-deductible after 2025 if Congress takes no further action.
Entertainment expenses related to a special company holiday party or summer picnic, including recreational facilities such as golf courses, remain 100% deductible if they are for the benefit of the employees. Additionally, certain entertainment expenses are fully deductible if they are taxable as compensation to the employee or independent contractor or if they are reimbursed expenses.
It is important to maintain proper documentation showing:
- Amount, time, date and place of expenditure
- Business purpose
- Business relationship of the expenditure
The IRS may examine such records during an audit.
1. Classify meals and entertainment expenses into:
- Entertainment expenses (non-deductible) – for expenses that are for entertaining clients, including entertainment meals
- Entertainment expenses (100% deductible) – for expenses such as free promotional items or entertainment services that are sold to customers
- Business meal expenses (50% deductible) – for meal expenses incurred where business is conducted, where the taxpayer is present and that are not lavish or extravagant
- Other meals (100% deductible) – for meals related to a holiday party, picnic and the like that are for the benefit of the employees
2. Focus on incurring deductible business expenses. This may include revisiting contracts or arrangements with entertainment service providers or revising spending budgets.
3. Educate employees about taxable entertainment expenses vs. reimbursed expenses. This may involve re-negotiating employee compensation or reimbursement agreements.
4. Consider spending more on promotional items instead of non-deductible entertainment expenses, since promotional items are fully deductible.
The consequences of these new deduction limitations should not be overlooked. Although IRS guidance is awaited on some of the changes, the best thing you can do is to be sure you understand the changes thoroughly, communicate that knowledge to your employees and make spending adjustments accordingly.