Can I Still Deduct the Costs of Entertaining Customers Under the New Tax Law?

The Tax Cuts and Jobs Act of 2017 (the New Tax Law) made many changes in tax code. The New Tax Law substantially lowered tax rates on all businesses, whether they pay taxes as a C or S corporation. In exchange for the lower rates, the New Tax Law also eliminated or reduced some popular and widely used business deductions. The New Law also raised many questions and created some confusion as to what is and is not a deductible business expense.

One of the deductions eliminated was for entertainment expenses. Prior to the New Tax Law, a business could deduct 100% of business expenses for entertainment, amusement, or recreation if the expenses were either “directly related” to the taxpayer’s trade or business, or directly preceding or following a bona fide “business discussion.” Under the Income Tax Regulations “entertainment” means any activity that is generally considered entertainment, amusement, or recreation, such as entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events, hunting, fishing, vacation, and similar trips.

The tax law also allowed taxpayers to deduct 50% of the cost of all business meals and beverages. To maximize the deduction, it was wise to negotiate a package deal that included all meals and beverages under a single price per person for any excursions or entertainment events to be able to deduct 100% of the costs.

Confusion arose because the New Tax Law entirely eliminates a deduction for entertainment, but did not eliminate the 50% deduction for business meals. Taxpayers are asking if 50% of the cost of meals can be deducted if a meal is provided at an entertainment event?

To clarify the rules, the Internal Revenue Service (IRS) intends to issue new regulations to answer these questions and clear up the confusion. In the meantime, on October 3, 2018, the IRS issued interim guidance that will apply until it issues its new regulations. The IRS has asked the public to submit comments for future guidance by December 2, 2018.

The interim guidance provides that a taxpayer may deduct 50% of the cost of business meals that meet the following criteria:

  1. The expense must qualify as an ordinary and necessary expense paid in carrying out the taxpayer’s trade or business.;
  2. The expense is not “lavish or extravagant under the circumstances;”
  3. The taxpayer or an employee of the taxpayer is present when the food and beverages are furnished;
  4. The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
  5. To prevent taxpayers from shifting the cost of the non-deductible entertainment event to the cost of the food and beverages, the food and beverages cost must be purchased and booked separately from the entertainment charge on any bill, receipt, or invoice.

IRS Notice 2018-76 (October 2, 2018).

For example, if a business charters a boat for a fishing excursion to entertain clients, the cost of the charter is not deductible. If meals are provided as part of the charter fee, these costs are also not deductible. If, however, the meals are invoiced separately from the cost of the charted boat, then 50% of the meal costs are deductible.

Accordingly, it is no longer recommended to bundle the cost of entertainment and food. Rather, if providing food and beverages in connection with an entertainment event, taxpayers should require that the vendor state the cost of the food and beverages separately from the cost of the entertainment. This will allow the taxpayer to deduct 50% of the costs of those meal and beverages.

The New Tax Law has also caused many flooring dealers to asking whether they are better being taxed as a C corporation in light of the new flat 21% or continuing to pay taxes as a pass-through entity, such as an S corporation. The next two issues of WFCA’s Premier Flooring Retailer (4th Quarter 2018 and 1st Quarter 2019), will include a two-part article, entitled With the New Tax Law, Should You Be a C Corporation? Not So Fast—It is Complicated, to help the flooring retailer, installer and contractor understand the issues and considerations to make an informed decision.

Notice: IRS Circular 230 Disclosure: To comply with certain U.S. Treasury regulations, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this communication, including attachments, was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding any penalties that may be imposed on such taxpayer by the Internal Revenue Service. In addition, if any such tax advice is used or referred to by other parties in promoting, marketing or recommending any partnership or other entity, investment plan or arrangement, then (i) the advice should be construed as written in connection with the promotion or marketing by others of the transaction(s) or matter(s) addressed in this communication and (ii) the taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor. To the extent that a state taxing authority has adopted rules similar to the relevant provisions of Circular 230, use of any state tax advice contained herein is similarly limited.

The information contained in this blog is abridged from legislation, court decisions, and administrative rulings, and should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.

Monday, November 5, 2018