The Tax Cuts and Jobs Act of 2017 (TCJA) made several changes to business deductions. These changes included a new disallowance of entertainment expenses. But what about business meals?
Section 13304 of the TCJA provided, among other changes, that Internal Revenue Code §274(a) was to be re-written to read: “No deduction otherwise allowable under this chapter shall be allowed for any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement or recreation,” or with respect to a facility used for those purposes. Previously, the expenses were not deductible unless the taxpayer could show that the expenses in question were directly related to, or, in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that such item was associated with the active conduct of the taxpayer’s trade or business (or with respect to a facility used for those purposes).
Neither the current nor former versions of the statute used the term “entertainment.” The statute has been broadened to prohibit all entertainment, amusement and recreation expenses without limitation. Are meals considered entertainment?
The answer is, it depends. Congress chose not to define “entertainment,” but instead directed the Secretary of the Treasury Department to issue regulations that define the terms as the Secretary saw fit. Such regulations are considered valid law, so long as the regulations are not clearly inconsistent with the language of the statute.
So the Secretary issued regulations to define “entertainment.” Treas.Reg. §1.274-2(b)(1)(i) provides that: “The term entertainment may include an activity, the cost of which is claimed as a business expense by the taxpayer, which satisfies the personal, living, or family needs of any individual, such as providing food and beverages, a hotel suite, or an automobile to a business customer or his family.” This definition encompasses business meals with prospective or current clients. Further emphasizing the point that business meals with prospective or current clients fall within the scope of entertainment (and are no longer deductible after the TCJA) are other regulations (issued before 2017) which limit “directly related” entertainment expenses as it pertains to business meals (Treas.Reg. §1.274-2(c)), and “associated with” entertainment expenses (Treas.Reg. §1.274-2(d)).
As such, the expense of business meals for current or prospective customers or clients is no longer deductible, effective January 1, 2018.
(APRIL 4, 2018 UPDATE – Based upon the fact that Congress retained Section 274(k) after the enactment of the Tax Cuts and Jobs Act, the American Institute of Certified Public Accountants (AICPA) has requested immediate guidance from David Kautter, Assistant Secretary for Tax Policy at the Department of Treasury, and William Paul, Acting Chief Counsel of the IRS that business meals which take place between a business owner or employee and a current or prospective client, are not lavish or extravagant under the circumstances, and where the taxpayer has a reasonable expectation of deriving income or other specific trade or business benefit from the encounter, are not disallowed under 274(k). The AICPA’s position can be found at https://www.aicpa.org/content/dam/aicpa/advocacy/tax/downloadabledocuments/20180402-aicpa-comments-sec274-meals-ent-transp-fringe.pdf. Clark Schaefer Hackett will continue to monitor these new developments.)
However, the label of a “business meal” does not mean that an expense is not deductible. Entertainment does not include any expenses incurred within a professional capacity. For example, the regulations provide that tickets to a theater would normally be considered entertainment expenses, but to a theater critic, such expenses would not be considered entertainment. For business meals, one would imagine this would apply to restaurant critics as well.
Meals provided for employees are not entertainment, and may be deductible. Stockholder meetings and other “bona fide business meetings of the taxpayer’s employees, stockholders, agents, or directors held principally for discussion of trade or business” is not entertainment, and remain potentially deductible. While the regulations require the primary purpose of the meeting to be to actively conduct the trade or business, the law does not address whether customers or clients are forbidden from attending those meetings, even if at a restaurant. Hopefully, the IRS will issue more guidance on that issue.
Expenses incurred for meals or food that is made available to the general public is not entertainment. Likewise, the cost of any food or meals that is sold to customers is not entertainment.
Expenses for food and beverages furnished on the business premises for employees (except for recreational, social, or similar activities) primarily for the benefit of employees, furnished in connection with business meetings of employees, stockholders, agents, or directors, and directly related and necessary to attendance at a business meeting or convention of any organization described in section 501(c)(6) (relating to business leagues, chambers of commerce, real estate boards, and boards of trade), to the extent they are deductible, are now limited to a 50% deduction.
The term “entertainment” is applied on an objective basis – business meals are considered entertainment regardless of one’s subjective intentions. The regulations clarify that expenses cannot be called advertising, public relations, or any other term in order to avoid the scope of the prohibition against the deduction of entertainment expenses.
Accordingly, the majority of client or customer meals are not deductible, but hopefully, more guidance will be forthcoming to address the issue.
If you have any questions about whether an item is now disallowed entertainment, contact Brett Bissonnette, JD, CPA at (513) 424-7693 or any of the qualified tax professionals at Clark Schaefer Hackett.