As tax practitioners, we know that meals and entertainment expenses can have a significant impact on the profitability of contracts and projects. These expenses often require careful scrutiny due to the unique and varied rules for deductibility that apply to them. In this blog post, we’ll explore the rules and regulations surrounding meals and entertainment expenses. And if you’re looking for more information on how these rules affect specific types of independent contractors such as truck drivers, be sure to attend 2023 Fall Tax School for the full scoop. Now, grab your popcorn and let’s dive in!
Let’s start with entertainment expenses, the costs associated with recreational activities that bring joy and amusement. Attending sporting events, parties, and stage shows are just a few examples of these enjoyable activities. In the past, deducting entertainment expenses was no walk in the park, with specific criteria to meet. However, after the enactment of the Tax Cuts and Jobs Act (TCJA) in 2017, things have become a bit simpler.
Under the TCJA, entertainment expenses have become largely nondeductible. This means that costs incurred for entertainment events, whether hosted or attended with clients or business affiliates, are no longer deductible. Even the expenses for using facilities for entertainment purposes, including rent, depreciation, and lease payments, fall into this nondeductible category. And remember, membership dues for clubs, regardless of their purpose, are also nondeductible entertainment expenses. It’s as if Uncle Sam said, “No deduction for you!”
Deductible Entertainment Expenses
Now, let’s move on to the bright side. Some entertainment expenses are still deductible if they are ordinary and necessary for your specific business. Let’s say you’re a floral designer like Pamela, and you host a floral show to promote and sell your beautiful arrangements. Since this event directly contributes to your business’s success, you can deduct the costs of hosting the floral show. It’s a home run for Pamela!
Exceptions to the Nondeductible Rule
There are a few exceptions to the general rule of nondeductibility for entertainment expenses. For instance, you can deduct the cost of food and beverages provided to your employees on your business premises. If you include entertainment expenses as compensation for your employees, those expenses are also deductible. And if your employer or others reimburse you for entertainment expenses, as long as they are substantiated and not included in your wages, you can deduct them too. So, hosting a holiday party or a social gathering for your employees can bring tax benefits along with the joy of celebration.
A Bite-sized Overview
While entertainment expenses might be a tough sell, meals have maintained a consistent set of rules for deductibility. The TCJA didn’t bring about significant changes in this area, except for a temporary provision in 2021 and 2022 that allowed a 100% deduction for business meals purchased from qualified restaurants, aiming to support the restaurant industry during the COVID-19 pandemic. That provision has since expired.
The 50% Limit
As a general rule, taxpayers are subject to a 50% deduction limit for business meals. This applies to meals during business meetings or while traveling for business. To be deductible, the meal must be ordinary and necessary for your business. But hold your horses, because the IRS clarifies that necessary doesn’t necessarily mean required. So even if it’s not a mandatory meal, you can still deduct it as long as it’s appropriate for your business. Good news for those impromptu client lunches at the local diner!
Exceptions to the 50% Limit
Now, let’s take a bite out of the exceptions to the 50% limit. If you provide meals as compensation to your employees or get reimbursed for meals without those reimbursements being included in your wages, you can fully deduct those meal expenses. The same goes for meals provided during events like holiday parties or other social gatherings. And guess what? If you make meals at functions available to the general public, excluding your employees or an exclusive guest list, you can deduct them too. Talk about a win-win situation!
Practitioner Planning Tip – When it comes to meals during entertainment, it’s essential to have explicit documentation and separation of food and beverage costs from other entertainment expenses. By keeping copies of invoices or itemized receipts, you can better defend your position if the IRS ever questions your deductions. So, remember, keeping good records is as American as baseball, fireworks, and apple pie!
As tax practitioners, it’s our duty to help our clients navigate the intricate world of tax deductions. Meals and entertainment expenses can be particularly tricky, with their own set of rules and exceptions. While the TCJA made entertainment expenses largely nondeductible, there are still avenues for deductions based on your business circumstances. Meals, on the other hand, maintain a 50% deduction limit, with some exceptions that can give you a full deduction. So, as you prepare tax returns and guide your clients through these deductions, remember to keep records, stay informed, and enjoy the process like a fireworks show on the 4th of July!
By Chris Korban, CPA
Tax Materials Specialist, U of I Tax School