Is your company ready for the changes related to the deductibility of meals and entertainment expenses? Effective for tax years beginning after December 31, 2017, the ‘Tax Cuts and Jobs Act’ (the Act) significantly changes the amount that will be allowed as a deduction for meals and entertainment expenses. It is important for companies to know of these changes so they can properly track and provide accurate information when preparing their 2018 tax returns.
In general, under the prior law, companies were allowed to deduct 50% of any meal expense if it was directly related to business activities or meal reimbursements for employees while traveling on business. There were a few exceptions to the 50% limitation under the prior law. Specifically, expenses for de minimis fringe benefits, such as coffee and donuts, occasional working lunch meetings, holiday parties or similar social events for employees, and expenses related to on premise meals provided for the convenience of the employer. For these exceptions, 100% of the expenses were deductible.
Under the Act, all meal expenses, including expenses for de minimis fringe benefits, meal reimbursements for employees while traveling on business, and expenses related to on premise meals, will be subject to the 50% limitation. Holiday parties or similar social events for employees will continue to be 100% deductible under the Act. In addition to these changes, effective January 1, 2026, companies will not be allowed a deduction for on premise meals. It is also possible that the IRS may look to disallow operating expenses, beyond just the food and beverage costs, related to on premise eating facilities.
The more dramatic changes relate to entertainment expenses. Under the prior law, if companies incurred expenses for entertainment, amusement, or recreation; and if those expenses were directly related to their business operations, they were allowed a tax deduction of 50% of the total expense.
Under the Act, no deduction will be allowed for entertainment expenses incurred related to business activities. One complicating factor to consider is that many times expenses include both a meal component and entertainment component that may prove difficult and burdensome for companies to separate from each other. The IRS may seek to deny the deductibility for meals that have some form of non-deductible entertainment included if appropriate documentation is not provided. In those situations, it would be crucial to obtain documentation supporting the deductibility of the meal portion and that there were business discussions that took place during the meal. The IRS does allow for the use of statistical sampling when identifying deductible and nondeductible expenses, as long as the guidelines set forth by the IRS are followed.
The Act significantly reduced the deductibility of expenses related to meals and entertainment. It also complicated the process of accounting for these types of expenses, and in certain situations, may require an increased amount of documentation to support these deductions. Companies need to consider the impact of these changes and we recommend creating new general ledger accounts in order to track meals separately from entertainment. In addition to making adjustments to the general ledger, companies should also review their documentation procedures related to combined expenses to ensure they are able to meet the burden of proof required by the IRS for any deductible portion.
For more information, contact the tax professionals at Larson & Company today.