Attention Law Firms: Are You Ready for Meals and Entertainment as State Tax Deductions?
Meals and entertainment (“M&E”) are often essential to a law firm’s operations. Not only do attorneys meet with clients and prospects in restaurants, on the golf course and elsewhere, but they also travel to meet with clients at their businesses and in courts wherever cases are litigated. M&E can be an essential component of networking and business development, fueling growth and increasing profitability.
Commentators have spent the last 12 months scrutinizing the Tax Cuts and Jobs Act’s (“TCJA’s”) changes to the federal rules for M&E deductions, but have given relatively little consideration as to whether or not the states will follow suit. What position are the states taking?
Using a small sample of states—including New York, New Jersey, California Connecticut, Massachusetts and Pennsylvania—we reviewed their approaches to M&E. Each jurisdiction, other than California, requires C corporations, including professional corporations or entities taxed as corporations, to follow the more-restrictive federal rules in capping most meal expenses at 50% and disallowing the deduction of any entertainment costs. In calculating state taxable income, these corporate returns begin with federal taxable income and add or subtract items that are taxed differently under the federal and state systems, such as accelerated tax depreciation, tax-exempt interest income and state taxes. Among the states that we considered, only California (which has adopted only select provisions of the TCJA), allows C corporations to avoid the new federal M&E limitations.
The results are a mixed bag in the pass-through entity arena of partnerships, LLCs and S corporations. New York State, New York City, Massachusetts and Connecticut pass-through entity returns also start with the federal amount in calculating state taxable income and, similar to C corporations, do not provide any specific taxpayer-friendly adjustment allowing greater M&E deductions. In so doing, these jurisdictions follow the TCJA’s limits on meals and the ban on the deduction of entertainment expenses.
For S corporations and partnerships, California, New Jersey and Pennsylvania offer a more favorable approach: New Jersey and Pennsylvania explicitly allow pass-through entities taxpayer-friendly adjustments culminating in a deduction of 100% of M&E expenses.
California still follows the Internal Revenue Code of January 1, 2015, which means that it has not adopted the TCJA limitations on M&E. Therefore, items such as tickets to sporting events or the theater will continue to be 50% deductible, and meals provided for the convenience of the employer will remain fully deductible.
Keep in mind that any M&E deduction remains subject to the §162 (or state-specific) requirements that the expenses generally be ordinary and necessary, not lavish or extravagant under the circumstances, that the taxpayer or an employee be present, and that there be a business purpose to the expense.
We focused on a relatively small sample of jurisdictions, and other states may take a similar or completely independent approach. This information was valid on the date of its initial publication, but states and cities are revising their laws and their interpretations of existing laws. Please keep this in mind, and review the most updated instructions and administrative guidance carefully before calculating a tax liability. This attention is especially important when estimating state tax withholding for non-resident partners and shareholders or filing extensions. Feel free reach out to a member of your EisnerAmper engagement team with questions.
|C Corporations||S Corporations||Partnerships/LLPs/LLCs|
|California||Does not follow TCJA M&E changes - Applies the IRC as of 1/1/2015 and the M&E limitations as of that date||Does not follow TCJA M&E changes - Applies the IRC as of 1/1/2015 and the M&E limitations as of that date||Does not follow TCJA M&E changes - Applies the IRC as of 1/1/2015 and the M&E limitations as of that date|
|Connecticut||Follows TCJA||Follows TCJA||Follows TCJA|
|Massachusetts||Follows TCJA||Follows TCJA||Follows TCJA|
|New Jersey||Follows TCJA||100% of M&E is deductible||100% of M&E is deductible|
|New York State and New York City||Follows TCJA||Follows TCJA||Follows TCJA|
|Pennsylvania||Follows TCJA||100% of M&E is deductible||100% of M&E is deductible|