Before your company opens up a new cafeteria for employees or starts courting potential clients, make sure you understand the new limitations on the deductibility of certain business meals and that entertainment expense deductions are now prohibited as set forth in the 2017 Tax Cuts & Jobs Act (TCJA). 

This article will examine the new requirements along with opportunities for partial deductibility of certain meal and entertainment costs, with a quick reference chart.

Prior to the TCJA, regulations permitted a 50% deduction for entertainment, amusement, or recreation-type expenses, so long as taxpayers could substantiate that the expenses were “directly related to” or “associated with” trade or business.¹ Given the broad application of these tests, taxpayers were previously able to deduct recreational and loosely related activities as necessary business expenses. However, the TCJA removed the Internal Revenue Code (IRC) language that previously allowed deductions for such catch-all activities.

This now-disallowed group of activities also encompasses facilities “used in connection with [a prohibited] activity,”² such as social or athletic clubs. However, a 50% deduction is still allowed for business meals so long as they are not “lavish or extravagant under the circumstances.”³

While the IRS does not provide specific examples of “lavish” or “extravagant” meals, the phrase “under the circumstances” indicates the subjectivity of these tests to be based on reasonableness, not dollar amount. For example, spending $5,000 on a meal in association with securing a $10,000 contract could be considered lavish, but this definition would likely not characterize a situation involving a $1 million contract.

Nonetheless, because of the disallowance of entertainment expenses and the continued allowance of business meals, food and beverages purchased during or in conjunction with entertainment activities must be itemized on a receipt or invoice, or altogether purchased separately from the related entertainment.⁴

Substantiation

In order to deduct a business meal, it would be insufficient for a taxpayer to merely identify a meal as business-related; similarly, submitting a calendar noting the name of the person with whom one has met would not be adequate. Taxpayers must document all present parties, the time, location, business purpose, and business relationship of all parties.⁵ While not required on a tax return, if the pertinent information is not available in the event of an IRS examination, any related meal expenses could be disallowed in their entirety.

To illustrate the above requirement, consider the following example:

Contractor A is a season ticket holder to his alma mater’s football team’s games, taking advantage of these events to discuss business and entertain existing or prospective clients. In addition to admission, the cost of tickets includes parking, food, and drinks. Under pre-TCJA law, Contractor A could deduct 50% of the cost of tickets so long as the conditions of one of the aforementioned tests were satisfied. However, under the new law, Contractor A can no longer deduct any portion of the tickets, even that which is attributable to parking, food, and drinks, as everything is included within the tickets’ cost.

Alternatively, under similar circumstances, if the cost of tickets does not include parking, food, or drinks – all of which Contractor A pays for separately from the tickets – the cost of the tickets and the entertainment-related travel remain nondeductible, while the food and drinks become 50% deductible.

Exceptions for Certain Entertainment-Type & Related Meals Deductions

Even though the TCJA eliminates the deductibility of entertainment expenses as a general group, the law does not eliminate (and thus retains) certain exceptions. The IRC still allows the deduction of entertainment-type (and related meals) expenses in nine specific instances,⁶ which can be separated into two groups: 50% deductible₇ and 100% deductible.⁸