Meals and no entertainment: M&E deduction diminished
Bad news: the meals and entertainment (M&E) deduction became much more boring after Jan. 1, 2018.
On Dec. 22, President Donald Trump signed into law H.R. 1, commonly known as the Tax Cuts and Jobs Act.1 The Tax Cuts and Jobs Act has revamped many different aspects of the tax law, including the widely-used M&E deduction.2 Often justifying the expense, businesses have used the M&E deduction to facilitate business relations through lunches, dinners, sporting events, golf outings and shows. The Tax Cuts and Jobs Act has severely limited or, in most cases, eliminated entertainment expenses that were once deductible.
Looking at the prior law
Under the pre-Tax Cuts and Jobs Act law, taking out business prospects or customers for a dinner and some evening entertainment was a great way to generate business. In addition to generating business, it also generated a tax benefit. The general rule was that no deduction was allowed with respect to an activity generally considered to be entertainment, amusement or recreation, unless the taxpayer could establish that the expense was ordinary, necessary3 and was directly related to or associated with the active conduct of the taxpayer's trade or business or income-producing activity.4
Establishing that the expense was ordinary and necessary was generally satisfied if entertaining clients or business people was customary in the taxpayer's trade or business.5 The second requirement of being either "directly related to" or "associated with" was the more stringent requirement. Directly related to meant the principle purpose of the event must have been the conducting of business.6 Because it is unlikely one could effectively negotiate purchase orders during a hockey game or a Metallica concert, the regulations allowed M&E expenses to be associated with a business purpose. This meant an M&E deduction was allowed if the event directly preceded or followed a substantial bona fide business discussion.7
If the taxpayer could establish that the expense was ordinary and necessary, and that it met the directly related to or associated with standard, the taxpayer would be allowed to deduct 50 percent of the total M&E expenditure. Taxpayers are required to keep adequate records to evidence the expense and establish the M&E deduction requirements had been met.8
Where we are now
The Tax Cuts and Jobs Act provides that, for expenses incurred or paid after Dec. 31, 2017, there is no deduction allowed with respect to an activity generally considered to be entertainment, amusement or recreation expenses that are directly related to or associated with the active conduct of the taxpayer's trade or business.9 Consequently, the entertainment deductions related to the active conduct of a taxpayer's trade or business will no longer offer a tax deduction benefit. However, taxpayers are still allowed a deduction of 50 percent of the food and beverage expenses associated with operating their trade or business.10 For instance, if a taxpayer takes a client out to a dinner and then to a baseball game, the tax deduction will be limited to 50 percent of the cost of dinner and no deduction will be allowed for the baseball tickets.
Under the current law, an interesting and inconsistent result emerges if a taxpayer gifts tickets to customers and does not attend the event themselves. Deductions for business gifts are limited to $25 per year, per individual.11 In the prior example, say the taxpayer still takes the client to dinner, but is unable to attend the baseball game himself and gifts a ticket to the client. In this scenario, the taxpayer would not only get the 50 percent deduction for the dinner but would get an additional $25 deduction for a business gift (assuming the tickets cost at least $25.) It appears the taxpayer will receive a better tax result by gifting the ticket to the client instead of bringing the client to the game.
On Oct. 3, 2018, the IRS issued Notice 2018-76 to provide transitional guidance on the deductibility of business meals under IRC Sec. 274. The notice affirms that business meals will remain 50-percent deductible if they are ordinary and necessary expenses in carrying on a trade or business and are not lavish or extravagant. In addition, the taxpayer (or an employee of the taxpayer) must be present at the furnishing of food or beverages. The notice goes on to clarify that in the case of food or beverages provided during an entertainment activity, if the food and beverages are purchased separately from the entertainment or are separately stated from the cost of the entertainment on a receipt, the taxpayer may deduct 50 percent of the cost of the food or beverages.
An example: Taxpayer A invites B, a business contact, to a baseball game. A buys the tickets for both A and B to attend the game. During the game, A buys hot dogs and beverages for A and B.
In this scenario, baseball is entertainment and, accordingly, the cost of the game tickets is an entertainment expense and is not deductible by A. However, the cost of the hot dogs and drinks, which are purchased separately from the game tickets, constitutes a business meal expense and is 50 percent deductible.
To summarize the key takeaways under the current law, taxpayers will no longer receive a tax deduction for expenses considered to be entertainment, amusement or recreation that are directly related to or associated with the active conduct of the taxpayer's trade or business. Taxpayers will continue to be allowed to deduct 50 percent of the food and beverage expenses associated with operating their trade or business. Finally, the limitations placed on M&E expenses through the Tax Cuts and Jobs Act apply to amounts paid or incurred after Dec. 31, 2017.
Tax planning tip
When splitting a business golf outing or sports event, offer to buy dinner if your guest picks up the greens fees or game tickets and call it even.
Andrew Seifert, JD is a tax consultant for Wipfli LLP, where he assists clients with complex tax issues, transactional advising and overall business consulting. In addition, Andrew frequently presents on tax-related matters. He may be reached at firstname.lastname@example.org or 651-766-2856.
1. P.L. 115-97
2. P. L. 115-97, Section 103304(a)
3. IRC Section 162
4. IRC Section 274(a)(1)(A)
5. IRC Section 162(a)
6. IRC Section 274(a)(1)(A)
7. Treas. Reg. Section 1.274-2(d)(1)
8. IRC Section 274(d)
9. IRC Section 274(a)(1)(A) as amended by H.R. 1 § 13304(a)(1)(A)
10. IRC Section 274(n) as amended by H.R. 1 § 13304(a)(2)(D)
11. IRC Section 274(b)(1)