The Tax Cuts and Jobs Act (TCJA) of 2017 called for the suspension of unreimbursed business expense deductions for taxable years 2018 through 2025. The loss of this tax benefit has been a concern among business owners. However, the change in the law applies only to expenses incurred by employees, whose expenses are claimed as miscellaneous itemized deductions on Schedule A of Form 1040. It is important to note that S corporation shareholders who perform services for the corporation are considered employees.
Partnerships and LLCs often have partners with home office expenses; mileage; phone expenses; travel, meals, and entertainment; continuing education, professional dues, and publications; and other business-related expenses. Many times, these expenses are disproportionate among the partners. When the partnership agreement calls for the partner to cover these expenses, they could be deducted as unreimbursed business expenses on Schedule E of Form 1040. This is common practice, especially in professional service partnerships such as law firms.
Despite the significant impact on employees and S corporation shareholders, business owners who are general partners or LLC members may continue to deduct qualified unreimbursed business expenses as a Schedule E offset, and self-employed individuals will continue to deduct these expenses on Schedule C of Form 1040.
Adequate records must be kept, substantiating the expenses and business purpose in a manner consistent with documentation requirements included in the Tax Code. Documentary evidence such as receipts, cancelled checks, or bills must be maintained, and the amount, date, and business purpose of each expense must be recorded.
Meals and Entertainment
Additional consideration should be given to business meals and entertainment expenses beginning in 2018. The new law drastically changed the rules governing these expenditures.
Under pre-TCJA law, ordinary and necessary expenses for an activity generally considered to be entertainment, amusement, or recreation, or for a facility used in connection with such an activity, directly related to the active conduct of the taxpayer’s trade or business or income-producing activity were generally 50-percent deductible. A 50-percent deduction was also allowed for expenses paid to a club organized for business, pleasure, recreation, or other social purposes if related to an active trade or business.
Under the new law, entertainment expenses are generally nondeductible. Effective for amounts paid or incurred after December 31, 2017, the Act repeals the rule that allows a 50-percent deduction for ordinary and necessary expenses for an activity generally considered to be entertainment, amusement, or recreation, or for a facility used in connection with such an activity. The Act also disallows a deduction for membership dues for any club organized for business, pleasure, recreation, or other social purposes, or expenses of a facility used in connection with such club. These expenditures are disallowed even if related to an active trade or business.
Under prior law, a 100-percent deduction was allowed for meals provided at the convenience of the employer, meals occasionally provided to employees, overtime employee meals, and food and drinks at the office if the expenditures were excludable from the employees’ gross income as de minimis fringe benefits. Effective for amounts paid or incurred after December 31, 2017, and before January 1, 2026, the above-mentioned expenditures are 50-percent deductible. Amounts paid or incurred after December 31, 2025, for the above-mentioned expenditures are entirely nondeductible.
Client, customer, or vendor business meals; meals during business travel; meals at a conference, seminar, or business league event; and meals during in-office business meetings that were previously 50-percent deductible remain 50-percent deductible under the new law. To be deductible, meals must be ordinary and necessary in the carrying on of the taxpayer’s trade or business and cannot be lavish or extravagant. The meal must also occur either during an active business discussion or in a clear business setting directly in furtherance of the taxpayer’s trade or business.
Employee celebrations such as a company/office picnic or company/office holiday party, client-reimbursed meals and entertainment expenses, and meals and entertainment included as taxable income to an employee or independent contractor that were 100-percent deductible remain 100-percent deductible under the new law.
Meals Associated with Entertainment
It is important to note that since deductions for entertainment expenses are now generally disallowed, deductions for meals that are associated with entertainment activities are also now generally disallowed. For business meals to be deductible, they must occur without the substantial entertainment distractions that might inhibit the conduct of business (e.g., meal expenses at night clubs, cocktail lounges, theatres, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacation, and similar trips).
The IRS is expected to issue additional guidance on the deductibility of meals and entertainment, including the definition of entertainment-related meals. In the meantime, it is recommended that general ledger accounts be established to separately track nondeductible entertainment, 50-percent deductible business meals, and 100-percent deductible meals and entertainment. It is expected that taxpayers will have to more closely weigh the business purpose of certain meals and entertainment expenditures now that the tax benefit has been reduced or eliminated.