Meals and Entertainment — Tax reform takes a bite out of allowable deductions

Melissa Abel (mabel@kpmg.com): Hi, I’m Melissa Abel, a manager in the Income Tax & Accounting group of KPMG’s Washington National Tax practice.

Carly Rhodes (carolynrhodes@kpmg.com): And I’m Carly Rhodes, a manager in our Compensation & Benefits group also with the Washington National Tax practice. In today’s podcast, we’ll be discussing the tax treatment of a common employer-provided fringe benefit that has seen added complexity and restrictions: meals and entertainment, or “M&E.”

Melissa: The 2017 U.S. tax law—commonly referred to as the Tax Cuts and Jobs Act, or “TCJA”—took a big bite out of the meals and entertainment deduction available to employers.

As an initial threshold, in order to deduct any expense for business M&E, a taxpayer must first demonstrate that the expense meets the general requirements under Section 162 of the Internal Revenue Code for ordinary and necessary business expenses paid or incurred in carrying on a trade or business.

Carly: Code Section 274 provides additional limitations on the deductibility of certain meal and entertainment expenses. These limitations must be considered even if the expense is otherwise deductible under a different code section.

Melissa: As a starting point under section 274(a), no deduction is allowed for entertainment, amusement, or recreation expenses. Section 274(n) limits the deduction available for food and beverage to 50 percent.

Carly: The TCJA has amended these rules and imposed more stringent limitations on deductions for meal and entertainment expenses that are paid or incurred after December 31, 2017.

Melissa: Generally, there are three broad categories of M&E expenses.

Carly: First, there are nondeductible expenses, for which any and all deduction has been completely disallowed. This includes expenses with respect to entertainment, amusement, and recreation as well as expenses related to any facility used in connection with these activities.

Melissa: Second, while the deduction available for business meals have generally been limited to 50 percent, this category of expenses has grown to encompass de minimis meals—such as coffee and donuts provided in employee breakrooms—and meals provided in an employer-operated eating facility.

Carly: Finally, we have 100 percent fully deductible expenses. Facility costs associated with an employer-operated eating facility are currently 100 percent deductible; however, the facility costs as well as expenses for food and beverage offered in an employer-operated facility will be fully disallowed after 2025. The fully deductible category also includes exceptions to the limitations, such as amounts treated as taxable compensation, certain reimbursed expenses, and social and recreational activities for employees.

Melissa: For costs paid or incurred prior to 2018, taxpayers may amend open tax years to analyze M&E expenses to help claim or increase permanent tax deductions in prior years.

Carly: For costs paid or incurred after 2017, M&E expenses may be analyzed to identify potential exposures in order to comply with the TCJA. This may require clarifying company expense policies, requesting that vendors break out separate expenses when invoicing, and implementing system-level changes to monitor disallowed expenses.

Melissa: Potential benefits of performing an M&E analysis study include:

• Improved tracking and reporting, by controlling spending and simplifying processes going forward
• Mitigated risk, by identifying potential tax exposures and isolating certain types of nondeductible expenses, and
• Increased potential cash flow, by identifying certain fully deductible expenses, which can permanently reduce federal and state tax expenses.

Carly: Taxpayers may want to consider requesting that vendors bifurcate the costs of certain low-value drinks and snacks provided in employee breakrooms from the costs of other business supplies if they are currently included together on a single invoice, as the deduction for coffee and snacks in the office is now limited to a 50 percent deduction while the other supplies may still be fully deductible.

Melissa: They likewise may want to work with other vendors to itemize invoices to separate out food and beverage costs or other costs from an invoice that includes entertainment expenses or other business expenses such as advertising costs. IRS Notice 2018-76 provides transitional guidance on the deductibility of expenses for certain business meals and provides some examples where business meal expenses are incurred in connection with entertainment expenses.

Carly: KPMG has a number of technology-enabled M&E expense methodologies to streamline the analysis process, manage data, and organize documentation. KPMG also collaborates with IBM Watson, an Artificial Intelligence platform for business, to enhance, scale, and accelerate M&E tax analysis.

Melissa: Thanks again for joining us today. Additional guidance on M&E deductions is expected this fall, and we’ll provide an update once it’s available.