By Jill Parsons, CPA
Tax Manager, ACM LLP
Each year I have a conversation with several of my small business tax clients that goes something like this:
Me: Thank you for taking the time to discuss meals and entertainment expenses for the year. My first question is about several entries each under $8 for Starbucks. Can you please tell me what those were for?
Client: Yeah, I stop there on my way to work every day. I need my double-shot espresso macchiato to function. I can write off my miles, too, right?
Me: Let’s go over the meals and entertainment expenses then I am happy to discuss auto expenses. I see a $750 payment to StubHub. Can you tell me a little more about that?
Client: Sure. I took some customers to a Broncos game and we had a few beers. We discussed business before the game.
Me: Okay. Just one more question: What was the $475 meals expense to Fancy Schmancy Restaurant on New Year’s Eve?
Client: As you know my wife is the bookkeeper for my business. She’s on the payroll. I took her out to dinner to discuss the business’s financial performance for the year. It was a business meeting.
To be sure the tax laws surrounding business meals and entertainment have always been a bit confusing. With the passage of the Tax Cuts and Jobs Act (TCJA) we now have new rules to learn and potentially a different approach to how we classify expenses on the books.
Before 2018, business meals and entertainment expenses were generally deductible at 50% if they could be considered ordinary and necessary, were not lavish or extravagant, and were directly related to the active conduct of a trade or business. There must have been a substantial and bona-fide business discussion before, during, or after the meal or event. If you did not discuss business with the customer or if you did not attend the event with your customer, then no deduction was allowed. If you ordered in lunch for a staff meeting or hosted a company holiday party the cost of the event was 100% deductible. Expenses such as premiums paid to a scalper, your daily non-business coffee or lunch, country club dues, and lavish meals were not tax deductible.
So, what has changed?
The biggest change is that entertainment is no longer a tax-deductible business expense. Entertainment, according to the IRS, also includes amusement and recreation activities. Does that mean you can no longer take your customers to a Broncos game? Of course not. It just means that the business cannot deduct the cost of the tickets on its tax return. Now, what if the business owner buys some hot dogs and beer for herself and her customers at the game? If the meal takes place between a business owner or employee and a current or prospective client, is not lavish or extravagant, and where the taxpayer has a reasonable expectation of deriving income or other specific trade or business benefit from the encounter, the cost of the food and drink is still deductible at 50%. The only catch is that the cost of the meals must be separately stated from the cost of the entertainment. The IRS does not allow inflating the cost of the food and beverage to circumvent the rules. What about the weekly staff meeting lunch? Unfortunately, that is now 50% deductible rather than 100% previously allowed. How about the business owner who took his wife/bookkeeper/employee out to dinner and discussed the financials? Tread lightly here and protect yourself. The IRS tends to look at spousal meals (where no one else is present) as personal and therefore not deductible. Make sure that there is no question that the meal has a business purpose. Beyond proving that the meal was ordinary and necessary, it is critical to document the purpose of the meeting, who attended, and where. And the office holiday parties? Yes; events such as company picnics and holiday parties are still 100% deductible.
Okay, so how does all this affect the bookkeeper?
It might mean adding a couple of accounts to your general ledger and keeping tax law changes in mind as he or she records the meals and entertainment expenses. Consider one account for 100% deductible meals, one for 50% deductible, and one strictly for entertainment. A note on travel meals: Generally, travel meals are 50% deductible. It is important to be sure they are in a meal account on the books and not combined with other travel expenses such as airfare or lodging. Otherwise, your CPA will be asking for the details come tax time.
As with everything tax, there are always exceptions and special rules depending on the circumstances. If you are unsure be sure to ask your CPA.
Jill Parsons is a Tax Manager at ACM LLP and would be happy to answer any questions you may have. She can be reached at firstname.lastname@example.org or 303.440.0399