The Internal Revenue Service (IRS) has released Interim Guidance with respect to the business expense deduction for meals and entertainment in the aftermath of the Tax Cuts and Jobs Act (the Act), an Act which significantly reduced deductions for expenses related to entertainment, amusement and recreation. Since the passage of the Act, social clubs have been concerned about the adverse impact of the Act on their operations. Social clubs may rely on the Interim Guidance until the IRS issues proposed regulations.
Social Club Concerns
- If a member of the club brings a foursome to his/her club for business reasons to enjoy golf and a meal, would the cost be tax deductible to the member?
- If a nonmember hosted an outing at the club for business reasons, would the cost be tax deductible to the nonmember or his/her employer?
- If a member hosts an outing at his/her club to further the member’s business objectives, would the cost be tax deductible to the member’s employer?
The responses to these important concerns may be definitively addressed in forthcoming proposed regulations to be issued by the IRS, but for the present, we have parsed the tax law, including the Act, and the Interim Guidance, in an effort to provide informal guidance with respect to the issues facing social clubs.
Tax Law
Pursuant to the Act, a deduction for business expenses with respect to entertainment, amusement and/or recreation is generally disallowed; however, the Act does not negatively address the deductibility of expenses for business meals.
- A business tax deduction for any item with respect to an activity that is of a type generally considered to constitute entertainment, amusement or recreation is disallowed.
- No deduction is allowed for the expense of any food or beverages unless (A) such expense is not lavish or extravagant under the circumstances, and (B) the taxpayer (or an employee of the taxpayer) is present at the furnishing of such food or beverages.
- The amount allowable as a deduction for any expense for food or beverages shall not exceed 50 percent of the amount of the allowable expense.
Prior Tax Law
Prior to adoption of the Act, a deduction was permissible with respect to an activity if the taxpayer established that: (1) the item was directly related to the active conduct of the taxpayer’s trade or business (the “directly related” exception), or (2) in the case of an item directly preceding, or following, a substantial and bona fide business discussion (including business meetings at a convention or otherwise), the item was associated with the active conduct of the taxpayer’s trade or business (the “business discussion” exception).
Under prior law, taxpayers could deduct 50 percent of meal expenses and could deduct 50 percent of entertainment expenses that met the directly related or business discussion exceptions.
The Act repealed the directly related and business discussion exceptions to the general prohibition on deducting entertainment expenses contained in the prior tax law. Thus, entertainment expenses are no longer deductible. Otherwise allowable meal expenses remain deductible, subject to a 50 percent limitation.
Entertainment
The term “entertainment” means any activity which is of a type generally considered to constitute entertainment, amusement and/or recreation, including entertaining at, among other places:
- Theaters
- Country clubs
- Golf and athletic clubs
- Sporting events
The term “entertainment” does not include activities such as (a) supper money provided by an employer to an employee working overtime, (b) a hotel room maintained by an employer for lodging of employees while in business travel status, or (c) an automobile used in the active conduct of trade or business. On the other hand, the provision of a hotel room or an automobile to an employee who is on vacation would constitute entertainment of the employee.
An objective test should be used to determine whether an activity is of a type generally considered to constitute entertainment. Thus, if an activity is generally considered to be entertainment, it will constitute entertainment for purposes regardless of whether the expenditure for the activity can also be described otherwise and even though the expenditure relates to the taxpayer alone. This objective test precludes arguments such as that “entertainment” means only entertainment of others or that an expenditure for entertainment should be characterized as an expenditure for advertising or public relations.
IRS Interim Advice
The IRS intends to publish proposed regulations clarifying when business meal expenses are nondeductible entertainment expenses and when they are 50 percent deductible expenses. Prior thereto, taxpayers may deduct 50 percent of an otherwise allowable business meal expense if:
- The expense is an ordinary and necessary expense;
- The expense is not lavish or extravagant;
- The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
- The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and,
- In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts. The entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.
Examples
For each example, assume that the food and beverage expenses are ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business and are not lavish or extravagant.
Example 1. Taxpayer A invites three business clients to play golf at A’s golf club. A pays the greens fees for the three business clients. While playing golf, A purchases food and beverages at the half way house. The club bills the greens fees separately from the food and beverage charges on the member’s bills.
The golf play is viewed as entertainment, and, thus, the cost of the greens fees is an entertainment expense and is not deductible by A. The cost of the food and beverages, which are purchased separately from the green fees, should not be viewed as an entertainment expense and is not subject to the disallowance under the Act. Therefore, A should be allowed to deduct 50 percent of the expenses associated with the food and beverages purchased.
Example 2. Taxpayer B invites her client to her city club for lunch. B pays for the costs of the lunch. The cost of the lunch should not be viewed as an entertainment expense and is not subject to the disallowance under the Act. Therefore, B may deduct 50 percent of the expenses associated with the food and beverages purchased during lunch.
Example 3. Taxpayer C, a nonmember, hosts a business golf outing at a club. May Taxpayer C’s employer, ZZ Corp., secure a business tax deduction for the cost of hosting a business golf outing at the club? Under the Act, it does not appear that a business deduction for the entire cost of the golf outing is available.
It would be prudent for the club to separately state the cost of food and beverages on the bill in an effort to permit the ZZ Corp., to deduct 50 percent of the food and beverages expenses, consistent with the advice in the Interim Guidance. The golf, or entertainment, portion of the outing would not be deductible.
Example 4. Taxpayer Z hosts a business golf outing at his club to further his business objectives as vice president of sales of AA Corp. The invoice issued by the club to the Taxpayer Z covers the entire cost of the outing, greens fees, as well as the cost of food and beverages, in a single amount. The cost of the golf play is a nondeductible entertainment cost. The cost of food and beverages, which were not purchased separately from greens fees, is not stated separately on the invoice. Thus, the cost of the food and beverages is an expense that is nondeductible. Therefore, none of the costs associated with golf outing is a deductible business expense.
Social clubs should review the implications of the Act and the Interim Guidance with their tax advisors. Clubs will likely recognize that, with a bit of planning, clubs can assist their members and nonmembers in securing a deduction for the food and beverage portions of events held at the club.
James J. Reilly, CPA, JD, is a partner at Condon O’Meara McGinty & Donnelly LLP, which is a premier accounting firm serving more than 340 private membership clubs in 16 states. He can be reached at 646-438-6203 or [email protected].
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