Changes to the way business meals and entertainment expenses are deducted could have major implications for your business.
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Starting 2018, business owners will no longer be able to deduct the cost of entertaining an existing or potential client.
Gone are the days when you could expense the cost of taking your client to a baseball game. Under the new tax law introduced as the Tax Cuts and Jobs Act, sporting event tickets such as sky box tickets, charitable sports events or contributions to an education institution to purchase tickets to an athletic event are all non-deductible items.
What about the cost of entertaining clients at night clubs, cocktail lounges, theaters, country clubs or golf and athletic clubs? Not deductible! The cost of entertainment-related meals is not deductible either.
That said, there are some entertainment expenses that are still eligible for favorable tax treatment. The cost of entertainment goods and services that are available to the public for free as promotional items or sold to customers, such as on a cruise ship or a dinner theater, are fully deductible.
Business meals also continue to be 50 percent deductible, but the new tax law places additional requirements on them. For example, it requires that business is conducted during the meal and the cost of the meal is not lavish or extravagant. Reasonableness and facts/circumstances tests need to be met in order to determine the latter.
Employee perks haven’t been spared from changes, either. Employee meals that were previously fully deductible are now subject to 50 percent limitation if they are:
- Provided on employer business premises to the employees for the convenience of the employer. These meals will be non-deductible after 2025 if Congress takes no further action
- Occasionally provided to the employees for weekend work or overtime
- Office snacks and beverages provided to employees on business premises
- Part of a package for a charitable sports event
However, entertainment expenses related to company holiday party or picnics, including recreational facilities such as swimming pools or golf courses, are 100 percent deductible if they are for the benefit of the employees. Certain other entertainment expenses are also 100 percent deductible if they are taxable as compensation to the employee or independent contractor, or if they are reimbursed expenses.
Changes to the treatment of meals and entertainment expenses make it especially important to maintain proper documentation to substantiate any expenses that qualify for deductions. Taxpayers must maintain documentation to show the amount, time, date and place of expenditure; business purpose; and business relationship of the persons entertained.
The IRS may examine such records during an audit.
Re-categorize business expenses: Consider classifying meals and entertainment expenses into the following categories:
- Entertainment expenses (Non-deductible)
- Entertainment expenses (100 percent deductible)
- Entertainment-related meal expense (Non-deductible)
- Business meal expenses (50 percent deductible)
- Other meal expenses (100 percent deductible)
Evaluate entertainment expenses: Businesses may want to examine what entertainment expenses they incurred and determine how to focus more on those expenses that are deductible under the new tax law. This may include revisiting contracts or arrangements with entertainment service providers or revising spending budgets.
Educate employees: Consider educating employees about taxable entertainment expenses versus reimbursed expenses. This may involve re-negotiating employee compensation or reimbursement agreements.
Adjust your promotional strategy: Businesses might want to consider spending more on promotional expenses instead of entertainment expenses, since promotional items are fully deductible.
Meals and entertainment play a critical role in networking and business generation activities for most businesses. Needless to say, the elimination of the entertainment expenses including entertainment-related meals is a major blow. As such, it shouldn’t be left out of the broader conversations about changes needed under the new tax law. It may be that losing some of the entertainment-related expense deductions will be offset by reduced tax rates in case of corporations and the new 20 percent qualified business income deduction for pass-through entities. A tax advisor can assist in evaluating the new tax law’s overall impact on your business.