Entertainment Expense Deduction Under New Tax Act
It was my goal this month to discuss the newly enacted pass through entity deduction. However, as I began to analyze the law, I realized that the provisions are a textbook example of complexity in the Tax Code. I decided to save you from the head spinning the law caused me.
If you really want to know about the pass through entity deduction, feel free to contact me. In a nutshell, all I can say is that although the owners of a pass through entity will get a deduction from income of 20% of the entity’s pass through “income”, wages received from the pass through entity are NOT subject to the deduction and there are limitations and phase outs on the actual amount of the deduction.
I will focus instead on a simpler provision of the new tax law, and one on which I have been getting a lot of questions from practitioners.
Prior to the recent changes made to the Internal Revenue Code, entertainment, amusement and recreation expenses were deductible if the taxpayer could establish that the expense was directly related to the active conduct of a trade or business, or that the expense directly preceded or followed a substantial and bona fide business discussion associated with the active conduct of a trade or business. The New Act completely repeals the deduction for entertainment, amusement and recreation expenses.
The Treasury Regulations define entertainment as “any activity which is of a type generally considered to constitute entertainment, amusement or recreation such as night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events, and hunting, fishing, vacation and similar trips”. Additionally, “entertainment may include an activity which satisfies the personal, living, or family need of any individual such as providing food, beverages, a hotel suite or automobile to a business customer or his family”.
It is possible for an expense to satisfy the personal, living or family needs of an individual, but not be considered an entertainment expense. For example, if you are working on a project and your employees have to work overtime to meet a deadline, purchasing food for the employees is not an entertainment expense. Likewise, paying for a hotel or rental car for an employee who is traveling for your business, is not an entertainment expense and may be deductible. If, however, you pay hotel and rental car expenses for an employee who is on vacation, then the expenses are considered entertainment and not deductible.
In determining whether an activity constitutes entertainment the regulations provide that an objective test is to be used. Hence, if an expense is generally considered to be entertainment, then it is not a deductible expense. However, the IRS will give consideration to the taxpayer’s business in determining whether an expense is entertainment.
In the event an expense can be classified both as a gift and as entertainment, or both as travel and as entertainment, for deduction purposes, the expense will be considered to be entertainment and not deductible.
Although the same Internal Revenue Code section deals with entertainment expenses and business meal expenses, the deductibility of these expenses is provided for in different subsections. The subsection dealing with the deductibility of business meal expenses was not repealed by the new tax law. Hence, as long as the business meal expense is not lavish or extravagant, and the taxpayer, or an employee of the taxpayer, is present at the meal, the expense can be deducted. However, the amount of the deduction is limited to 50% of the expense.