With great fanfare, the Tax Cuts and Jobs Act (TCJA) eliminated deductions for business entertainment expenses, beginning in 2018. But, not completely.
Despite the fears of a number of tax commentators, guidance recently issued by the IRS preserves deductions for business meals incurred in connection with entertainment, albeit in limited circumstances (IRS Notice 2018-76, 10/3/18).
First, here’s some background information. Prior to the TCJA, you could deduct 50 percent of the cost of qualified business entertainment, as long as you met strict substantiation requirements spelled out in IRS regulations. This covered entertainment that was “directly-related to” or “associated with” the business.
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Frequently, the cost of meals and beverages was included in such entertainment. For instance, if meals were held in a clear business setting, like a hospitality suite at a convention, they qualified as directly-related entertainment.
Similarly, if you treated a customer to a meal after a substantial business discussion, you could write off 50 percent of the cost as associated-with entertainment. But then the TCJA repealed the deduction for business entertainment.
Where did that leave deductions for business meals? Clearly, meals incurred while traveling away from home on business, such as a business trip to finalize a contract with a client, remains deductible, subject to the 50 percent limit.
But the rules weren’t as clear for meals incurred in connection with entertainment. Fortunately, the IRS has provided some leeway. In the 2018 Notice, it says that taxpayers may deduct 50 percent of the cost of business meals if:
- The expense is an ordinary and necessary business expense paid or incurred during the tax year
- The expense is not lavish or extravagant under the circumstances
- The taxpayer, or an employee of the taxpayer, is present when the food or beverages are furnished
- The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact
For food and beverages provided during or at an entertainment activity, they are purchased separately from the entertainment or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts.
Caution: The rules can’t be circumvented by inflating amounts charged for food and beverages in connection with entertainment activities.
To illustrate the new rules, the Notice provides three examples where business taxpayers attended games with business contacts.
Example 1: A taxpayer takes a customer to a baseball game and buys the hot dogs and drinks. The tickets are nondeductible entertainment, but the taxpayer can deduct 50 percent of the cost of the hot dogs and drinks purchased separately.
Example 2: A taxpayer takes a customer to a basketball game in a luxury suite. During the game, they have access to food and beverages, which are included in the cost of the tickets. Both the cost of the tickets and the food and beverages are nondeductible entertainment.
Example 3: The same facts as in Example 2, except that the invoice for the basketball game tickets separately states the cost of the food and beverages. In this case, the taxpayer can deduct 50 percent of the cost of the food and beverages.
The IRS is expected to issue new regulations with more details. In the meantime, you can rely on the 2018 Notice.