Unfortunately, the Tax Cuts and Jobs Act (later abbreviated TCJA) seems in some areas to have been written in crayon leaving a wide swath of ambiguity in its interpretation. One of the topics lurking in the gray zone is the requirements for deducting business meal expenses. The purpose of this blog post is to parse through some of the terms and tests, and shine a light on which expenses may be eligible for deduction post TCJA.
Assuming meals are deductible at all, there are a few hoops to jump through in order to deduct meal expenses (which will be subject to limitations). We will break these down into 4 important points to consider in relation to the meals deduction.
- All business expenses need to meet the deductibility requirement of being “ordinary and necessary” in the normal course of business. These terms are broadly defined to mean customary, usual, appropriate, or helpful. If it is reasonable in your business to provide potential clients or business partners with meals, then the expenses you incur for that purpose should generally be able to pass this first test.
- The second level of tests applicable to meal expenses must also be satisfied. This test requires that the expenses be “directly related” or “associated with”. A simple way to think about this rule is that in order to pass, the meal must involve active discussion specifically centered on immediate revenue.
The “directly related” test requires that the main reason for the meeting must be business and you must have engaged actively during the meal in a meeting/discussion etc. So, if you take a client out to dinner with the purpose of just generally building goodwill – those expenses would not be deductible. Another way the “directly related” test can be met is by providing the meal in a clear business setting. For example; ordering dinner to your conference room for the meeting. Discussions or meetings that take place during a social gathering do not qualify the expenses for the deduction.
If your expenses do not meet the requirements for the “directly related” test, the expense may still qualify as “associated with”. This test is easier to satisfy, as it only requires that the meal is before or after a substantial discussion required in the active conduct of business. The good news is that under this test the “goodwill” dinner I mentioned earlier would qualify for the deduction. However, there is one catch to be aware of; you or an employee of yours must be present in order to qualify under the “associated with” test. If you simply cover the cost of a client meal after a business meeting but don’t join them than your meal expense won’t qualify.
- The IRS will need to see proof that your expenses qualify for the deduction. Reasonable estimates are not sufficient. You’ll want to establish the amount spent, the time and place, the business purpose and relationship of those involved. We recommend you set up careful and detailed record-keeping to keep track of each meal and its related business purpose. One thing to note: expenses equal to or greater than $75 require a receipt or similar substantiation.
- Finally, there are two deduction limitations I would like to highlight. First, lavish or extravagant expenses are not deductible. It is important to remember this doesn’t necessarily impose fixed limits on the costs of meals. Expenses at restaurants with higher price points can still qualify, as long as it is reasonable. Second, and probably most importantly: once the expenditure qualifies it is only 50% deductible. This greatly reduces the tax benefit of business meals, and would be something to keep in mind in deciding whether to document expenses and take the deduction.
Bottom line is; even though the deduction has changed significantly, it could still reduce your taxes due if you understand the concepts behind the terms and document your expenses accordingly.