Understanding New Rules Regarding Business Entertainment Deductions

If you own a business or work in a business, chances are that at some point, you’ve engaged in business-related entertainment of some sort. If so, you’ve probably reported those entertainment expenses as deductible on your taxes.

While the recently passed Tax Cuts and Jobs Act of 2017 (the Act) has far-reaching impacts in many areas of tax law, one of those areas is business-related entertainment expenses. The reality is, the rules around entertainment expenses have changed—and if you or your business engages in business entertaining of any kind, it’s important you take note.

What’s changed?                                    

In general, the Act provides for stricter limits on the deductibility of business meals and entertainment expenses. Under the Act, entertainment expenses incurred or paid after Dec. 31, 2017 are nondeductible unless they fall under the specific exceptions in Code Section 274(e). One of those exceptions is for “expenses for recreation, social, or similar activities primarily for the benefit of the taxpayer’s employees, other than highly compensated employees.” As an example, office holiday parties are still deductible. Business meals provided for the convenience of the employer are now only 50 percent deductible, whereas before the Act, they were fully deductible. Barring further action by Congress, those meals will be nondeductible after 2025.

Businesses should keep the new rules in mind as they plan their 2018 meals and entertainment budgets. See below for a list comparing the rules before and after the Act.

Recreational Expenses for Employees (e.g., Christmas parties, annual picnics, or summer outings intended for employees generally)

• 2017 Expense (Old Rule): 100% deductible
• 2018 Expense (New Rule): 100% deductible

Entertaining Clients (Meals include food or beverages including beverages or drinks served apart from meals of the taxpayer and his business associates at a cocktail lounge or hotel bar not involving distracting influences such as a floor show Re. § 1.274-2(f)(2)(i)(b)

• 2017 Expense (Old Rule): Entertainment & meals – 50% deductible
• 2018 Expense (New Rule): Meals – 50% deductible

• 2017 Expense (Old Rule): Event tickets, 50% deductible for face value of ticket; anything above face value is non-deductible
• 2018 Expense (New Rule): No deduction for entertainment expenses

• 2017 Expense (Old Rule): Tickets to qualified charitable events
  • Meal portion, 50% deductible
  • Remaining portion 100% deductible
• 2018 Expense (New Rule): Same as 2017

Employee Travel Meals 

• 2017 Expense (Old Rule): 50% deductible
• 2018 Expense (New Rule): 50% deductible

Meals Provided for Convenience of Employer

• 2017 Expense (Old Rule): 100% deductible provided they are excludible from employees’ gross income as de minimis fringe benefits, otherwise; 50% deductible
• 2018 Expense (New Rule): 50% deductible (nondeductible after 2025)

What steps should your company take?

Review and revise your corporate entertainment policy as needed.

Company officials should review changes to the deduction disallowance with a qualified tax professional and amend this policy accordingly.

Expenses must be “ordinary and necessary” in carrying on taxpayer’s trade or business and the taxpayer must show the expense was either “directly related to” or “associated with” the “active conduct” of such trade or business.

• Directly related – active business discussions or meetings
• Associated with – expense incurred directly preceding or following active discussions (same day or facts and circumstances test) Reg. §1.274-2(d)(3)(ii)
• For record keeping, need amount, time, place, business purpose and business relationship

Establish specific general ledger accounts.

In order to easily identify how to treat various expenses during tax return preparation time, separate accounts should be established for three primary purposes:

• To identify entertainment expenses that do not qualify for the business deduction
• To identify those that fall under the 50 percent deduction limit
• To identify those that are subject to a 100 percent deduction

Consider the inclusion of entertainment expense reimbursements in taxable wages.

In order to preserve the deductibility of the entertainment expense under compensation expense, consider including these amounts in the employees’ taxable wages. In addition, these wages can be “grossed up” where federal income tax and FICA taxes may be paid on behalf of the employee.