A common issue that small business owners face is how to ensure they don’t run afoul of the IRS when incurring expenses that are truly business-related but are also personally beneficial to the owner in some way. Now, in light of recent tax reform, the Tax Cuts and Jobs Act (TCJA) has changed the landscape for the tax treatment of some of these types of business expenses. This may require businesses to track these expenses somewhat differently than before and owners may need to revisit and/or change some of their existing business policies.
In a nutshell – IRC Section 274 provides that business entertainment deductions have generally been disallowed and business meals are generally limited to a 50% deduction. There are some experts that have argued that TCJA will make most meals fully nondeductible, but it appears that it is not Congress’ intention to fully exclude deductions for business meals (that are not lavish or extravagant) beyond the current 50% limitation. We continue to wait for further guidance from the IRS clarifying the way the rules will be interpreted.
However, there are exceptions (as always) to the rules, so some expenses are still fully deductible. Let’s look at the hurdles to be able to take the maximum deductions allowed.
Business Entertainment – Under TCJA, “business entertainment” expenses are generally nondeductible. Of course, many business owners contend that these entertainment expenses are “ordinary and necessary” to their business as a part of their overall marketing and goodwill framework. Since these expenses will continue to be common, accepted and helpful to many businesses, they continue to be appropriate to be paid for by the business and appear in the business books and financial records. They simply will join a handful of other business expense categories for which the IRS denies a deduction. THE EXCEPTIONS: Owners can still claim a 100% deduction for business entertainment expenses if they are for an event that’s open to the public (e.g. marketing open house). The full deduction is also available for celebratory or team-building events that are primarily for the benefit of your employees (e.g. holiday party).
Along similar lines, dues and membership fees for clubs that are organized for business, pleasure, recreation or social purposes (e.g. country clubs, golf clubs, athletic clubs) will continue to receive nondeductible treatment from the IRS. THE EXCEPTONS: Owners can still claim a 100% deduction for dues and membership fees for professional organizations, civic organizations and chambers of commerce.
Business Meals – For the last 25 years, the IRS and Congress have imposed limits on business meals in an attempt to recognize the legitimate business purpose for the meal balanced with the personal benefit of eating a meal that the taxpayer would eat anyway. For this reason, the IRS has allowed a 50% deduction for many business meals categories while offering 100% deductions for some exceptions. TCJA has expanded the 50% category slightly to include more expenses that were previously fully deductible.
As always, for a meal to qualify as a “business meal,” it must be directly related to some element of the business and the owner must retain substantiating records. Meals with the staff, snacks in the office, meals while traveling for business and meals with business associates where business is discussed – all qualify as a legitimate business expense. THE EXCEPTIONS: Similar to entertainment expenses for the staff, owners may still claim a 100% deduction for celebratory meals (e.g. holiday parties, birthdays, practice anniversaries) and meals for staff events (e.g. team-building events). These meals must be primarily for the benefit of the non-highly-compensated employees (think “rank and file” employees). Additionally, meals that are provided to the general public as part of a marketing plan are also 100% deductible.
Bottom Line – Now that it appears that TCJA will narrow the scope of those meal and entertainment expenses that are fully deductible, business owners should evaluate their internal policies that may be impacted by these new guidelines to see if a change is warranted. Additionally, owners will need to work with their accountants to potentially track these expenses differently than before. Finally, owners that operate their business within an S-Corporation should consult their CPAs and financial advisors regarding possible implications that a large number of nondeductible or partially deductible expenses will have on their S-Corp basis.
For purposes of the table below, "business associate" refers to partners, employees, coworkers, clients, customers, patients, referral sources and the like.