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New Business Meals Guidance Creates Substantiation Concerns

October 4, 2018
By Stephanie Cumings
Published in Tax Notes

Taxpayers might not be prepared to separately document meals this year as required by new guidance on the business meals deduction, according to practitioners.

Whether client business meals would still be deductible was “the big issue” coming out of the 2017 tax law’s changes to meals and entertainment, Michael L. Hadley of Davis & Harman LLP told Tax Notes.

An October 3 IRS notice makes clear that those meals will continue to be 50 percent deductible, but it requires, among other things, that meals provided during an entertainment activity be separately billed.

Employers will need to look at how they’ve tracked their spending, and they may have to reconstruct some invoices this year to meet the new substantiation requirement, Hadley said. Ruth M. Wimer of Winston & Strawn LLP agreed that properly documenting meal expenses could be an issue.

Under the prior law, both meals and entertainment expenses were 50 percent deductible, so there was no need to distinguish them on an invoice, Hadley said. But the Tax Cuts and Jobs Act (P.L. 115-97) eliminated the deduction for entertainment, leaving practitioners unsure if client business meals would be construed as a form of nondeductible entertainment.< /p>

IRS Notice 2018-76, 2018-42 IRB 1, clarifies that a business meal will remain deductible as long as it’s considered an ordinary and necessary expense under section 162(a) and not “lavish or extravagant.” Also, an employee and potential client must be present at the meal, and the meal must be purchased or billed separately from any entertainment. Taxpayers can rely on the notice until proposed regulations are issued, it says.

Meals Are Sacred

Practitioners praised the IRS’s decision to preserve the deduction as pragmatic. Kathy Petronchak of Alliantgroup LP, who chaired the American Institute of CPAs’ meals and entertainment task force, said she was “thrilled” with the notice.

“The examples address the issues that were outlined as a concern in this area, and this is clearly a win for taxpayers,” Petronchak said. “It’s great to see the definition of ‘entertainment’ applied in a way that makes sense to taxpayers.”

Wimer said the notice essentially rules that “meals are sacred.” Without this “very generous” guidance, Wimer said it would have been difficult for employers to discern on their own which meals cross the line into entertainment. Conversely, it would also have been difficult for the IRS to administer a rule on where that line should be drawn, she said.

Hadley agreed the notice was a great result, adding that it appears to be consistent with Congress’s intent.

A ‘Lavish’ $100 Bottle of Wine?

Wimer said that the deduction rules outlined by the IRS are mostly nothing new, including the requirement that the meal not be “lavish or extravagant.” Practitioners said that historically, there was a high bar for denying a deduction on that basis. Hadley said that denial was rare, if it “has ever happened at all.”

A $50,000 bottle of wine would be a good example of “lavish and extravagant” under the prior understanding, Wimer said. But she said she won’t be surprised if auditors are tougher on this issue in the future.

From a policy standpoint, Wimer noted that employer deductions like the one for entertainment were largely curtailed by the TCJA in exchange for the lowered corporate rate.

“In light of the philosophy of the bill… [the IRS] may say we’re going to have a lower standard for when you get to lavish and extravagant,” she said. “Maybe instead of the $50,000 bottle of wine, you can’t deduct the $100 bottle wine.”

Hadley said he didn’t see the lack of guidance on the phrase to be a pressing issue.

Remaining Questions

Hadley said that hopefully the IRS will provide additional guidance on meals provided to employees. Under the TCJA, a new 50 percent deduction limitation applies to some food and beverage construed as a de minimus fringe benefit, like coffee and donuts. The TCJA also
repeals the deduction entirely for employee cafeterias and meals provided for the convenience of the employer beginning in 2026.

Wimer advocated for guidance on when a business trip is considered entertainment, such as whether an entire trip would be nondeductible if a percentage of it constituted entertainment. She also questioned how transportation costs — like using a company jet — should be allocated when some travelers use the jet for business while others use it for entertainment.

Another issue that could use some clarity is conference sponsorships, which was also an issuebefore the TCJA, Hadley said. He said it’s unclear to what extent the sponsorship of a dinner at a conference is advertising, entertainment, or a meal.

Regarding the notice’s request for comments on revising the definition of entertainment in reg. section 1.274-2(b)(1)(i), Wimer said the definition could use an update given that it contains some dated language like “cocktail lounges” and “supper money.”

Kathy Petronchak is the Director of IRS Practices and Procedure at alliantgroup and is part of the alliantnational group in Washington, DC. In this role, she provides assistance on a wide range of procedural issues related to IRS procedures, such as pre-filing agreements; alternative dispute resolution; statute of limitations; account problems, and penalty issues. She also assists in representing clients before the IRS with an examination or appeal issue.

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Contact our team today with any tax controversy concern you’re facing. We fight every day to protect the interests of the taxpayer, and we look forward to putting you in the best tax situation possible.

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