The Tax Cuts and Jobs Act made major changes to the laws on business deductions for entertainment and meals, and these new rules will have some impact on most businesses.
Prior to 2018, a business could deduct up to 50 percent of entertainment expenses if they were directly related to the active conduct of a trade or business or were incurred directly before or after a substantial and bona fide business discussion. Now, no deduction is allowed for any expenses related to activities generally considered entertainment, amusement, or recreation.
Similarly, social, athletic, or sporting club memberships are not deductible. Businesses may no longer deduct the cost of a suite at a sports arena, country club memberships, theater tickets, or fishing trips to name a few common expenses incurred for the purpose of building relationships and generating business.
The cost-benefit analysis of developing relationships with clients and business partners has been shifted, and this change could have a significant impact on how businesses operate. Without the deduction, the cost of these activities has essentially gone up. As businesses begin to feel the burden of the higher cost, we may see businesses begin to cut back on these types of expenses. Or, it may turn out that enough business gets done on the proverbial golf course that businesses will still find these activities to be worth the expense even without the deduction.
Businesses can still deduct the cost of holiday parties and summer picnics. Recreational and social activities primarily for the benefit of non-highly compensated employees are not subject to the disallowance of a deduction for entertainment, amusement, or recreational expenses.
There has been a considerable amount of confusion surrounding the Tax Cuts and Jobs Act’s impact on deductions for meals. However, for the most part, those rules have not changed. Early commentators contributed to the confusion by speculating that meals with clients or prospective clients are “entertainment,” so no deduction would be allowed. This worry spread through the tax advisor community — despite of the fact that the current tax law continues to have a specific provision related to deductions for “business meals.”
In May 2018, at the ABA’s Tax Section meeting, the IRS confirmed that 50 percent of the cost of “business meals” continues to be deductible unless the meals are “lavish.” Just as before, if business is discussed and the meal is not extravagant, businesses can deduct 50 percent of the cost.
Businesses can also continue to deduct 50 percent of the cost of an individual’s meals connected with work-related travel outside of the individual’s normal commute. The cost of meals provided as part of social or recreational activities primarily for the benefit of non-highly compensated employees continue to be 100 percent deductible, so the cost of food and beverages at the holiday party or summer picnic are still deductible.
The new tax law does, however, include a major change regarding meals provided to employees. Prior to 2018, food and beverages provided to employees were 100 percent deductible if such expenses were excluded from gross income as de minimis fringe benefits or were provided on the employer’s premises for the convenience of the employer.
This covered, for example, coffee in the breakroom, doughnuts on Fridays, in-house cafeterias, employee lunch meetings, and meals provided to employees working overtime. Now, such food and beverage expenses are subject to the 50 percent limitation, and, beginning in 2026, these types of expenses will not be deductible at all.
Again, with the reduced deduction and its eventual elimination, it will be interesting to see whether businesses cut back on or attempt to eliminate these types of expenses. Will this be the end of Google’s legendary free employee cafeterias? Or, will the advantages of offering this perk be worth the nondeductible expense?
Only time will tell how the changes in the Tax Cuts and Jobs Act will impact business operations and local economies.
This article was reprinted with permission from Albuquerque Business First.