The 2018 Tax Cuts & Jobs Act brought a lot of changes to the federal tax scheme, but the word “Cuts” in the title was a little misleading. Not every aspect of the laws that greatly overhauled our federal tax code actually resulted in cuts to our federal tax liability. The changes to our tax laws that caused reductions to federal tax liability for some were paid for by changes that caused increases to federal tax liability for others. At least some of the federal tax cuts being enjoyed by others have been paid for by a reduced deduction for meals & entertainment by businesses. While larger companies have most likely been able to absorb the effects of this reduced deduction, smaller businesses may have felt a harmful impact.
Meals & entertainment provided to employees as compensation and for company parties are 100% deductible, the same as under the old rules. The IRS has clarified this rule by stating that at least half the employees must be present for the meal or entertainment to be deductible (theoretically, at a company-wide holiday party, more than half the employees would be present). Other snacks and meals provided to employees while they are working during the day or traveling for the company, but not in a group comprising more than half the company’s entire workforce, are only 50% deductible. Meals or entertainment cannot be “lavish or extravagant” to be deductible – not easy to define but I would suggest not buying foie gras or hiring Cirque du Soleil to perform for your employees. Also, when the owner travels on company business, the 50% deduction on meals continues to apply.
Any meals provided to clients and employees or the owner(s) while discussing business remain at a 50% deduction, while money spent entertaining clients – i.e., concerts, watching professional sports, playing golf – are now completely non-deductible. No doubt that these rules have greatly angered owners of golf courses and the boards of country clubs, but it is doubtful they caused any downward pressure on ticket prices at most professional sports or concert arenas (unfortunately, whether you wanted to take clients or go on your own). Membership at most country and social clubs had already been declining heavily over the years as a lot of business and social networking moved online. Nevertheless, there will always be professions with clients who feel afternoons at a golf course can never be replaced and will always spend the money, regardless of what can be deducted (money spent on food and alcohol while golfing or afterwards, remains deductible).
Here remains the big question – when I worked in a tax practice in the large firm world, there were large events where meals and entertainment that were attended by both employees and clients. Food would be consumed and entertainment enjoyed by both groups of people. In that situation, the food eaten by employees and owners would be 100% deductible (provided at least half the company’s employees attended) while any food eaten by clients would be only 50% deductible. Entertainment that employees enjoy would be fully deductible while anything the clients enjoyed would not be deductible at all. The problem is, both groups of people are in the same room at the same time. Does the IRS expect you to ask your employees and clients who ate which food, and who actually watched the entertainment, so you can deduct these expenses properly? No guidance has been provided in this area, nor has there been any real definitions of what is considered “lavish and extravagant”. If your business does have such an event, the best to do would be keep a tally of the total number of employees and clients that attended and plan on deducting a pro-rated portion of the entertainment costs. For example, if you had 25 employees and 75 clients attending, then deduct 25% of what was spent on entertainment, as your employees comprised 25% of the people viewing the entertainment, and there is no deduction for the other 75%. As far as food and beverages go, if at least half your employees were attending then deduct 25% of the food expense, plus another 50% of the remaining 75% of the food expense. This calculation is a little more complex. Suppose you spent $ 1000 on food and beverages for the aforementioned event. You would deduct $ 250 up front for what your employees presumably consumed, then 50% of the remaining $ 750 spent on what your clients consumed, which would be $ 375. $ 250 plus $ 375 equals $ 625, or 62.5% of what you spent on food and beverages would be deductible.
At the end of the day, it would seem like these policies passed by our Congress ultimately encourages businesses to spend more on their employees and less on their clients. Others might argue that businesses will spend money feeding and entertaining their clients regardless of what the tax rules are, so why give them any kind of deduction (a far cry from the philosophy of the Reagan administration in the 1980s, when meals & entertainment spent on clients was 100% deductible). The fact remains though, without any clients, you would have no business, and thus, no employees. However you feel this policy has affected the way your business operates, it is essential that you properly allocate between the meals & entertainment spent on your clients versus meals & entertainment for your employees, as the IRS will no doubt bring this issue up during an audit of your business.