IRS Allays Concern Over Fate of Meals Deduction (article)
The glass is half full for taxpayers as a result of IRS guidance published October 3 on the deduction for business meals. The IRS signaled that 50 percent of business meal expenses remain deductible in the wake of the new tax law known as the Tax Cuts and Jobs Act (TCJA). While a few additional conditions are added to support the 50 percent deduction, this form of client goodwill can continue essentially without dilution. Furthermore, taxpayers can also maintain the 50 percent deduction for business meals incurred at entertainment venues with proper planning.
Brief History of Meals and Entertainment Deductions
Expenditures for both meals and entertainment were 50 percent deductible prior to the TCJA. Entertainment expenses were eligible for the 50 percent deduction to the extent they were directly related to the active conduct of a trade or business, or were associated with it in the case of entertainment expenditures that preceded or followed a substantial business discussion or meeting. Prior to the TCJA, meals (i.e., food and beverage) expenses were 50 percent deductible to the extent the taxpayer was present when the meals were furnished, and to the extent that the expenses were not lavish or extravagant. However, there was significant ambiguity over meals expenses regarding their potential classification as entertainment expenses. Practitioners and taxpayers wondered whether the deduction requirements for meals expenses were in addition to the requirements for entertainment expenses, or were the separate requirements for meals expenses alone.
How Tax Reform Affects Meals and Entertainment Deductions
The distinction of meals from entertainment expenses was not critical prior to the TJCA because either way, the expense was 50 percent deductible and the deduction requirements for entertainment expenses normally were met for meals expenses anyway. But the TCJA repealed the 50 percent deduction for entertainment expenses after Dec. 31, 2017, which now makes the potential distinction critical.
If meals expenses are a subset of entertainment expenses, then meals expenses (including the vast category of client business meals) are generally nondeductible under the TJCA. Various exceptions apply for certain categories of meals expenses, but there is no exception for client business meals. Taxpayers were rightfully concerned about the status of this important deduction under the TCJA.
Meals expenses could have been viewed as part of entertainment expenses prior to the TCJA. A compelling example is contained in the legislative history to the Revenue Act of 1962, where the Senate declared flatly that “’entertainment’ includes any business expense incurred in the furnishing of food and beverages.” The law also implies this result when it provides the exceptions to expense disallowance for certain categories of meals, the logic being that there would be no need for exceptions if meals were not subsumed into entertainment.
Fortunately for taxpayers, the IRS did not take this view. This may have been justified by the legislative history to the TCJA, where the Senate stated, “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 statement does not directly address client business meals, but insinuates that they are “still” 50 percent deductible because such meals expenses are among “the food and beverage expenses associated with operating their trade or business.”
In any event, the IRS did not confront the 1962 legislative history or the construct of the law concerning its exceptions. Instead, the IRS simply stated, “[U]nder prior law, taxpayers could deduct 50 percent of meals expenses and could deduct 50 percent of entertainment expenses that met the directly related or business discussion exceptions.” This IRS position clearly distinguishes meals expenses from entertainment expenses under prior law. This taxpayer-friendly position sets up the basis for the current guidance.
Clarification Provided for Meals and Entertainment Expenses
The IRS stated in Notice 2018-76 that taxpayers may continue to deduct 50 percent of an otherwise allowable business meal expense if:
- The expense is an ordinary and necessary expense under Section 162(a) paid or incurred in carrying on any trade or business;
- The expense is not lavish or extravagant under the circumstances;
- The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
- The food or beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
- In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts.
The first condition was implicit under the prior law. The second and third conditions explicitly were part of the prior law. So, the fourth and fifth conditions are the new elements of a 50 percent deductible client business meal expense. Taxpayers meeting these conditions can rely on the IRS guidance to support the 50 percent deduction until the guidance is replaced with regulations.
In order to maximize the 50 percent deduction for meals expenses, taxpayers must examine arrangements at entertainment venues to ensure compliance with the fifth condition. For example, a taxpayer that incurs expenses for a luxury suite or skybox will not be able to deduct the expenses of the suite or skybox itself, but to the extent food or beverages are separately itemized on the invoice for such occasion, those itemized expenses are eligible for the 50 percent meals deduction.
Analyzing Meal and Expense Deduction Opportunities
The IRS guidance is welcome news to taxpayers because it resolves a significant ambiguity about the TCJA favorably. Taxpayers should analyze any entertainment-related expenses to determine whether changes to documentation and invoicing are necessary to maximize the 50 percent meals deduction. To learn more about the 50 percent client business meals deduction and the various rules for other meals expenses, please contact your local CBIZ MHM tax professional.
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