Entertainment Expenses IRS Holiday Parties Documentation Exceptions Tax Reform

Published: Dec 13, 2018
Topics: Tax
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In the aftermath of tax reform, and in light of the holiday season, the last quarter of the year invites heightened tax questions from businesses about meal and entertainment expenses. Is the company holiday party a write-off? How about a client meal at a sporting event?

The new rule eliminating deductions for most entertainment expenses are well known, but businesses have wondered whether a meal provided at an entertainment event can still qualify for a 50% deduction. Also, while such expenses previously could be kept in one ledger, the new tax law compels separate documentation of each.

The Internal Revenue Service recently issued transitional guidance under Notice 2018-76 to clear up lingering confusion about amended IRC Sec. 274. Before planning their next event, businesses should get up to speed on what expenses are deductible under the new law. Here are the main points and scenarios to keep in mind to maximize deductions under the new rules.

Don’t forget the exceptions!
Company socials, including anniversaries, holiday parties, and picnics, are still fully deductible. This includes entertainment costs, such as live music, which may accompany the event. Also, tax-exempt organizations and board-of-director meetings can still fully deduct expenses associated with socials. Many companies may not be aware of these exceptions, and mistakenly lump such events in with other nondeductible entertainment costs—missing out on a valuable opportunity. To claim the full deduction, however, a company social must be open to all employees or the public, not simply a select group of highly paid executives—individuals the IRS defines as earning more than $120,000 a year ($125,000 in 2019).
Consider the substance of the event
Perhaps a salesperson attends a convention in Las Vegas, where a customer resides. The two go out to dinner, with live music. The business can likely claim a 50% deduction on the meal, if business was discussed at some point in the outing. On the other hand, if a business invites clients to a luxury suite at a sporting event, with catered food and drink, the nature of the event takes priority, making the meal secondary and therefore non-deductible by being pooled with entertainment, even if business was discussed. Similarly, though holiday parties are otherwise fully deductible, a business should carefully consider the location. The gathering could be construed as an entertainment event, and not a company social , if it occurs at a sporting venue rather than, say, company offices or a restaurant.
Maintain proper documentation
It should be obvious that proving the legitimacy of meal expenses is essential. Receipts are required for meals over $75 (corporate cards given to employees also are acceptable). Businesses must document each meal’s time and place, cost, attendees and business relationship, and the business purpose. The last two are commonly missed items in IRS audit challenges, so be vigilant. It’s sufficient to state, for example, “2018 year-end tax planning lunch” as the business purpose. Without this simple notation, the IRS will assume the meal was extended to a friend or as a courtesy. Finally, where a business may previously have had a single account, it should now have three to track entertainment, food, and holiday parties or company socials.
Keep costs reasonable and necessary
Recent IRS guidance emphasizes that business meals for current or potential customers and contacts will be disallowed if costs are deemed lavish or extravagant. In practical terms, if a business takes a high-net-worth client out to dinner, and purchases a $1,000 bottle of wine, the entire meal will be nondeductible. There is no bright-line test in terms of a threshold amount of what is considered lavish, and is instead viewed on a case-by-case basis if the deduction is challenged.

Ultimately, businesses should strengthen documentation, have a separation of meals and entertainment for accounting and record keeping, and take a second look at venue choices and guest lists when planning events. These are important elements both to maximize the M&E deduction and reduce the company’s audit risk.

Business Tax Quarterly - Winter 2018