When is an entertainment an expense?
The tax rules related to meals and entertainment have changed, and left some uncertainty in the gap between the old law and the new.
Before the Tax Cuts and Jobs Act, the deduction allowed for entertainment expenses was limited to 50 percent of the amount otherwise deductible. Under the TCJA, the deduction for entertainment is completely repealed. Prior to the act, a 50 percent deduction was allowed for expenses related to business meals that were not lavish or extravagant. The confusion results from the issue of whether such business meals fall under the entertainment umbrella, or are still deductible.
“It now raises the question of what is an entertainment expense,” said Nathan Smith, director at the National Tax Office at Top 10 Firm CBIZ MHM. “Taxpayers have to be certain as to what falls under that category. It made no difference before, since there was a 50 percent deduction either way. Now, if it’s entertainment, it’s totally nondeductible.”
Until the IRS comes out with guidance in the area, the confusion will remain, according to Smith: “Some would argue that taking a client out for a meal clearly falls under entertainment. You could make a strong case for that by looking at the legislative notes for prior legislation, which suggest that meals are entertainment. On the other hand, the committee reports for the current law passed last December indicate they did not intend to change prior-law treatment for business meals. But the actual law that’s on the books doesn’t say this.”
“The consensus is that business meals are not caught under the entertainment umbrella and remain 50 percent deductible, which is what the committee report indicated, but it’s not the law,” he continued. “Nothing in the code says that meals are only entertainment and can be nothing else. The 50 percent deduction for business meals will likely remain, but we just don’t know for sure.”
“It will be some time before we see guidance on this,” said Meredith Kowal, senior manager of R&D tax credit services at Top 100 Firm Aprio.
“It comes down to intent – are you really entertaining customers or are you having a business discussion to solve an issue,” she explained. “Documentation is increasingly important this year, as it will provide more opportunity to deduct items now considered ‘gray area’ due to the vague rules.”
“The IRS will provide more guidance in the coming months,” she said. “What it will come down to is whether there is a business purpose, and what is the business purpose? What people don’t realize is that extravagant entertainment – such as a luxury suite at a ballgame – has always been disallowed. The luxury suite portion was disallowed in the past but the regular ticket price was deductible.”
And contrary to common misconceptions, internal expenses such as holiday parties, and team-building outings that boost employee morale are still fully deductible, Kowal indicated. “And sponsorships are often included in the same contract as a suite or box,” she said. “While the suite or box is no longer deductible, the sponsorship is still deductible.”
“My interpretation now, without more clarification, is that a meal is a meal, and entertainment is entertainment,” said Emily Matthews, principal at Boston-based Edelstein & Co. “So if you’re going to a game, the tickets are not deductible, but if you go to dinner beforehand and talk about business, that’s trickier. Arguably the meal would be 50 percent deductible, but there is some clarity to be had there.”
“Clearly the idea is to cut back on entertainment side, but to allow for the business meal to take place,” said Roger Harris, president of Padgett Business Services. “Make sure that while you’re eating you’re discussing business matters. If the conversation is boring and you feel like falling asleep, it’s probably deductible.”