FGMK TAX GUIDANCE: Changes to the Meals and Entertainment Deduction under the Tax Cuts and Jobs Act of 2017

On December 22, 2017, the President signed into law the legislation commonly referred to as the Tax Cuts and Jobs Act of 2017 (the “TCJA” or “Act”)[1].  The Act cut the top corporate tax rate from 35% to 21% and the top individual rate from 39.6% to 37%.  In addition, the Act modified various provisions of the Internal Revenue Code (the “Code”), including section 274, which disallows the deduction of certain expenses.  The below commentary and accompanying chart provide an overview of the modifications made to section 274 regarding the deductibility of meals and entertainment.  

Meals & Entertainment Deduction – Pre-TCJA

Section 162(a) of the Code provides that there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.  Prior to the Act, section 274(a) denied an otherwise allowable deduction for any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, unless the taxpayer established either:

  • The item was directly related to the active conduct of a trade or business; or
  • In the case of an item that directly preceded or followed a substantial and bona fide business discussion, the item was associated with the active conduct of a trade or business.[2]

Section 274(k)(1) further provided that, unless meeting an exception under section 274(e), such a deduction for food or beverage would not be allowed, unless:

  • Such expense was not lavish or extravagant under the circumstances; and
  • The taxpayer (or an employee of taxpayer) was present at the furnishing of such food or beverages.

If the taxpayer satisfied the provisions of sections 274(a)(1)(A) and 274(k), the deduction was limited to 50% of such expenses pursuant to section 274(n).[3] 

Meals & Entertainment Deduction – Post-TCJA

The Act modified section 274(a) by eliminating the "directly related or associated with" language.  As a result, section 274(a) now denies a deduction for any expenses with respect to an activity considered to constitute entertainment, amusement, or recreation (collectively referred to as “entertainment”). 

The Act’s elimination of any deduction for entertainment expenses raised a critical question as to whether the modification also eliminated the deduction for customary business meals, which would include customary client business meals and customary business associate meals during which business is discussed.  A review of the Code history and respective legislative history indicates that "entertainment" as used in section 274(a) does include customary business meals.  Consequently, the Act’s elimination of “entertainment” as a deductible expense also eliminated deductible expenses for customary business meals, unless the taxpayer can establish that it meets an exception under section 274(e). 

Some practitioners have contended that customary business meals remain deductible without the need to meet an exception under section 274(e).  As support, they cite the Act’s Committee Report, as well as sections 274(k) and 274(n).  However, neither the Committee Report nor the cited Code provisions support such an argument. 

The statement in the Committee Report on which practitioners have relied provides in pertinent part, “However, taxpayers may still, generally, deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel).”[4]  The error in the reliance on this statement in the Committee Report is that statutory interpretation starts with the language of the law.  If the statutory language is clear and unambiguous, then it must be applied as written.  Here, the Act clearly eliminates “entertainment,” which has long been interpreted to include customary business meals.  Nonetheless, even if one could rely on the Committee Report to contend that Congress did not intend to eliminate customary business meals, the fact that the Committee Report utilizes employee business travel and not a customary business meal in the often-cited statement contradicts the very argument that practitioners have attempted to make by relying on the statement.  If Congress meant the statement as an indication that it intended to maintain the deductibility of expenses for customary business meals, it would have cited that as an example and not a business expense that remains deductible under section 162(a), as such expenses have never fallen under section 274(a).

Sections 274(k) and 274(n) also provide little support for the contention that customary business meal expenses remain deductible, barring an otherwise applicable section 274(e) exception.  Though titled “Business Meals”, section 274(k) does not provide an exception to the general rule under section 274(a), rather, section 274(k) limits section 274(a) and sets forth additional criteria that an expense item for food or beverage must meet to be deductible.  Therefore, section 274(k) does not constitute a permissive exception allowing for such a deduction, but rather establishes additional criteria that a food or beverage item, otherwise deductible under the Code, must also meet to be deductible.  Similarly, section 274(n) is not a separate provision establishing the deductibility of a food or beverage expense item.  Rather, it provides a 50% limitation on an expense item, otherwise deductible under the Code.  Sections 274(k) and 274(n) provide limitations on meals served to employees on the premises and meals expensed by an employee while traveling: neither provision constitutes support for the deduction of customary business meals. 

Due to the language of the Act’s modifications, customary client business meals are no longer deductible if paid or incurred after December 31, 2017.  The only exception would be if a taxpayer can establish an exception as provided under section 274(e), e.g. the taxpayer is reimbursed for such expense.[5]  

As for a customary business associate meal, a reasonable basis exists to continue to deduct expenses paid or incurred for customary business meals with business associates.  Despite the modification of section 274(a), the Code retains section 274(e)(5), which provides a deduction for expenses incurred by a taxpayer which are directly related to business meetings of his employees, stockholders, agents, or directors.  While this provision traditionally has been cited for larger meetings, the language provides a reasonable basis for the continued deductibility of expenses paid or incurred for smaller gatherings, including the one-on-one business associate meeting, as long as business is discussed during the course of the meal.

Conclusion

As a result, an expense paid or incurred for a customary business meal may not qualify for a deduction under section 162(a), unless a taxpayer can can establish an exception to the disallowance provision in section 274(a), e.g. section 274(e). 

For any questions regarding the deductibility of expenses under section 274, please contact FGMK.

 

For any questions on section 199A please contact your tax advisor at FGMK.

Chuck Schultz                                                               Jeff Golds

Partner                                                                          Manager

312.818.4303                                                               847.940.3260

CSchultzIII@fgmk.com                                               JGolds@fgmk.com

 

[1] Pub. L. 115-97

[2] IRC § 274(a)(1)(A), prior to the passage of the TCJA.

[3] In addition, the taxpayer had to meet the documentation substantiation requirement under IRC § 274(d). 

 

[4] The Tax Cuts Jobs Act Conference Report to Accompany H.R. 1, 406 (a near identical statement appears in the House Bill and Senate Amendment sections).

[5] In such a case, the non-deductibility of the expense would shift to the client reimbursing the taxpayer for the cost of the meal.

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