Megan Valent – In his 2019 State of the Union speech, President Trump addressed one of his proudest accomplishments—The Tax Cuts and Jobs Act. On December 22, 2017, the most significant overhaul of the U.S. tax code in 30 years was enacted. Among its many changes, the Tax Cuts and Jobs Act lowered the corporate tax rate from 35 percent to 21 percent, doubled the standard deduction, and expanded the child tax credit. Yet, new tax laws are a product of give-and-take. Federal income tax rates have been cut, but as a result certain tax deductions available to employers have been cut as well. For instance, deductions for entertainment, amusement, or recreation expenses under § 274 of the Internal Revenue Code are no longer available.
The Treasury Regulations describe entertainment as “any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertainment at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events . . . .” Before the Tax Cuts and Jobs Act, under § 274 of the Internal Revenue Code employers were permitted to deduct 50% of expenses related to doing business while “entertaining.” There were only two exceptions to the rule. The taxpayer had to establish: (1) the item was directly related to the active conduct of the taxpayer’s trade or business, or (2) in the case of an item directly preceding or following a substantial and bona fide business discussion, the item was associated with the active conduct of the taxpayer’s trade or business. So, for example, before January 1, 2018 employers were permitted to deduct 50 percent of entertainment expenses incurred for the purchase of Super Bowl tickets as long as the employer could establish that the purchase was either directly related to or associated with the active conduct of the employer’s trade or business.
However, as a result of the Tax Cuts and Job Act, employers are no longer permitted to deduct expenses incurred in relation to entertainment—yes, this means no more tax deductions for sporting events or golf club memberships. Under § 274 of the Internal Revenue Code, entertainment expenses incurred on or after January 1, 2018 are nondeductible to the employer. This is a major change from the previous rule on the deduction of entertainment expenses, as employers will as a result be less willing to entertain clients without the deduction.
This change to the entertainment expense deduction further brings about debate as to whether certain meals expenses may be deducted by the employer as well. The IRS issued a notice in October of 2018 to provide some transitional guidance on the deductibility of certain business meals under § 274 of the Internal Revenue Code. Sure, meals at an “entertainment event” may be deducted by the employer. However, the meals must be purchased separately from the entertainment expense, or the cost of the food and beverages must be stated separately from the cost of the entertainment on one or more bills, invoices, or receipts.
Employers will only be able to see the effects of this change when they receive their 2018 tax returns. Nonetheless, it will be interesting to see how the IRS treats meals versus entertainment deductions, as it is a hard line to draw for tax purposes. One may imagine a situation where an employer decides to take a potential client to a cocktail lounge or sporting event and naturally decides to treat the client to a meal. The two are not mutually exclusive, and this is a normal business occurrence. Yet, now one transaction is deductible to the employer while the other is not.
Deductions play a huge role in determining what expenses to incur in running a business. This change to § 274 of the Internal Revenue Code will force employers to double-think whether or not it is a good idea to entertain a potential client. Nonetheless, business owners and employers must be willing to learn about all of the significant changes brought about by Tax Cuts and Jobs Act, as this change to the entertainment deduction is only one of many.
