Meals and Entertainment After TCJA 2017

Before enactment of the Tax Reform Act of 1986, the business meal requirement, according to the Joint Committee on Taxation’s Blue Book, was as follows.¹

Under prior law, expenses for food and beverages were deductible, without regard to the “directly related” or “associated with” requirement generally applicable to entertainment expenses, if the meal or drinks took place in an atmosphere conducive to business discussion. There was no requirement under prior law that business actually be discussed before, during or after the meal.

We called this pre-1986 meal a “quiet business meal” because you could deduct the meal and beverages without discussing business. Newspapers in New York and Washington, D.C., among other places, were calling this the “three-martini lunch” to highlight the fact that business need not be discussed.

The Tax Reform Act of 1986 did two things to client and prospect meals. First, it reduced the deductions from 100 to 80 percent. Second, as stated in the Blue Book in its description of the new law (with bold emphasis by us):²

Accordingly, an expense for food or beverages is not deductible unless (in addition to generally applicable deduction requirements) the taxpayer

1. establishes that the item was directly related to the active conduct of the taxpayer’s trade or business, or, 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), that the item was associated with the active conduct of the taxpayer’s trade or business, and
2. substantiates the deduction as required by section 274(d) and Treas. Reg. sec. 1.274-5(b)(4) (Revised 5/18/2010, see Reg. Sections 1.274-5T(b)(3); 1.274-5T(b)(4)³).

Under this requirement, a business meal expense generally is not deductible unless there is a substantial and bona fide business discussion during, directly preceding, or directly following the meal. The Joint Committee went on:⁴

Under the Act, as under prior law, the Internal Revenue Service and the courts are not to apply the Cohan approximation rule to allow deductibility of any food or beverage expense, other entertainment expense, or other expenditure subject to substantiation pursuant to section 274(d) if the expenditure is not substantiated in accordance with section 274(d) and the regulations thereunder.

In summary, the Tax Reform Act of 1986 added the business meal with a client or a prospect to the entertainment rules that required either a directly related business discussion or a meal associated with such a discussion for the meal to qualify for deduction.

In addition, the 1986 act subjected the business meal to the entertainment documentation requirements that required you to prove the five elements below:⁵

• Amount. Amount of each separate expenditure for entertainment, except that such incidental items as taxi fares or telephone calls could be aggregated on a daily basis.
• Time. Date of entertainment.
• Place. Name, if any, address or location, and destination of type of entertainment, such as dinner or theater, if such information is not apparent from the designation of the place.
• Business purpose. Business reason for the entertainment or nature of business benefit derived or expected to be derived as a result of the entertainment and, except in the case of business meals described in Section 274(e)(1), the nature of any business discussion or activity.
• Business relationship. Occupation or other information relating to the person or persons entertained, including name, title, or other designation sufficient to establish a business relationship to the taxpayer.

The conference report adopted the Senate amendment.⁶

The provision provides that no deduction is allowed with respect to (1) an activity generally considered to be entertainment, amusement or recreation, (2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes, or (3) a facility or portion thereof used in connection with any of the above items.

Thus, the provision repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer’s trade or business (and the related rule applying a 50 percent limit to such deductions).

The repeal means the rules that allowed the client and business meals when directly related to or associated with the active conduct of your business are now gone. You can see this when you compare the tax code before and after this tax reform as below.

Here’s the way IRC Section 274(a) read before tax reform

(a) Entertainment, amusement, or recreation.

(1) In general. No deduction otherwise allowable under this chapter shall be allowed for any item-

(A) Activity. With respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, unless the taxpayer establishes that the item was directly related to, or, 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), that such item was associated with, the active conduct of the taxpayer’s trade or business, or

(B) Facility. With respect to a facility used in connection with an activity referred to in subparagraph (A). In the case of an item described in subparagraph (A), the deduction shall in no event exceed the portion of such item which meets the requirements of subparagraph (A).

Here’s the way IRC Section 274(a) reads after tax reform

(a) Entertainment, amusement, recreation, or qualified transportation fringes.

(1) In general. No deduction otherwise allowable under this chapter shall be allowed for any item-

(A) Activity. With respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or

(B) Facility. With respect to a facility used in connection with an activity referred to in subparagraph (A).

In addition to the above changes that eliminated directly related and associated entertainment deductions (including business meals), tax reform also eliminated any documentation of such expenses when it removed IRC Section 274(d)(2), which required substantiation for “any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity.”

The elimination of the substantiation is logical, since the expenses are no longer deductible.

Tax reform also eliminated IRC Section 274(n)(1)(b), which applied the 50 percent deduction rule to entertainment, amusement, or recreation or with respect to a facility used in connection with such activity.