Industry Insights

In one of the largest revisions to the income tax code, the Tax Reform Act of 1986 began limiting deductions for business meals and entertainment. Prior to 1986, business meals and entertainment were 100 percent deductible; business meals and entertainment are now typically subject to a 50 percent limitation.

Many taxpayers may be unaware of the exceptions to the 50 percent limitation and could potentially be overpaying their income tax liabilities. As taxpayers focus on year-end tax planning opportunities, they may want to re-evaluate policies and procedures for capturing and reporting business meal and entertainment information.

Here are examples of expenses that are 100 percent deductible:

• Expenses related to recreational activities for employees – Expenses related to recreational, social or similar activities primarily for the benefit of employees are exempt from the 50 percent limitation.  Examples include, but are not limited to, holiday parties, company picnics, retirement parties, new-employee lunches, team-building events and project completion parties.
• Expenses that qualify as de minimis fringe benefits – Expenses excluded under the de minimis fringe benefit rule include items such as coffee, donuts and other break food provided to employees, occasional meals provided to employees during meetings and occasional business meals involving only employees.
• Expenses that qualify as charitable contributions – If a charitable event includes a meal and/or entertainment, only the amount attributable to the meal and/or entertainment is subject to the 50 percent limitation. The remaining portion is deductible as a charitable contribution.
• Reimbursed meal expenses – Amounts incurred in connection with services rendered to another person under a reimbursement or other expense allowance arrangement are not subject to the 50 percent limitation. It is important to communicate to your customers and/or vendors which party is subject to the 50 percent limitation for business meals and entertainment.
• Expenses for items made available to the general public – Items such as promotional popcorn, snacks or meals preceding a sales presentation to potential customers are exempt from the 50 percent limitation.

In addition, here are some expenses that have additional limits to their deductibility:

• Expenses related to luxury or “skyboxes” – Expenses related to the purchase or lease of a skybox or other private luxury box are generally nondeductible. The deduction is limited to the face value of non-luxury box seats.
• Country club or other social membership dues – No deduction will be allowed for amounts paid for membership in any club organized for pleasure, recreation or other social purposes.

Special rules also apply to the cost of food and beverages consumed while away from home by individuals subject to Department of Transportation hours-of-service limitations. These rules apply to certain air transportation employees, interstate truck operators, railroad employees and merchant mariners.

Business meal and entertainment expenses are highly scrutinized by the IRS, especially when dealing with closely held businesses. Therefore, it is important to retain the necessary documentation to support the amount of an expense and its business purpose. Implementation of internal policies and procedures to capture the necessary information will not only protect you against future IRS scrutiny, it may also uncover significant tax savings opportunities.

For larger taxpayers, the IRS has provided statistical sampling methods that can be used to establish the amount of substantiated meal and entertainment expenses exempted from the 50 percent deduction allowance.

Contact your BKD advisor if you have any questions regarding how your company treats business meals and entertainment expenses.