Having a business meeting over a meal or celebrating a big contract with a team happy hour are common events. Before the 2017 Tax Cut and Jobs Act (TCJA), meals and entertainment directly related to a business activity were considered a “reasonable and customary” business deduction, subject to strict rules. For example, meals and entertainment that were considered “lavish” or where the taxpayer or her employee was not present were not tax deductible.
Passing the TCJA changed all of that. Or did it? Some confusion is still out there, leading to some people thinking that meals and entertainment expenses are no longer deductible. Not true! That misunderstanding could lead to missing some business deductions, and paying higher taxes. Not good!
In reality, the new tax law is so vague it does not specifically define the expense commonly known as a “business meal.” TCJA language retains the requirement that “the taxpayer or his agent” be present for the business meal to be deductible. However, it does not retain the “directly related” and “associated with” standards that used to apply.
The change in meals and entertainment language and how it will be interpreted by taxpayers and their tax advisors has not been tested. Recommended practice under TCJA is in line with common practice pre-TCJA. So what does that mean for you?
Under TCJA, businesses can deduct 50% of the cost of meals and entertainment when:
- The taxpayer or his agent is present and conducting business.
- Expenses are not lavish or extravagant under the circumstances.
- Records are kept of the date, amount, business purpose and attendees.
These “new” requirements look a lot like what most of us have been doing since 1986, the last time tax law changed related to business meals and entertainment. So don’t worry about taking a client out to a dinner meeting. Have a team meeting at the happy hour location, and then stay for some team bonding. Keep the expenses reasonable, maintain complete records, and take that tax deduction. It’s okay.
Frequent readers of my blog know that I recently attended Tax Summer Camp, better known as the 2017 IRS Tax Forum, held in five cities across the country. At this year’s forum in Washington, DC, over 2,700 tax professionals heard about tax trends and issues from IRS representatives and experienced tax practitioners.
Two of the 18 sessions that I attended (yes, I said 18!) addressed documentation required by the IRS to support business income and expenses reported on a tax return. The tax rules generally require the same documents that you already keep to maintain the records used to monitor your business activities and prepare financial statements.
The IRS Forum emphasized four rules to support business income and expenses:
- Business income should be supported by invoices, IRS Forms 1099, receipt logs, bank deposit slips, online receipt records, cash register tapes, and other documents that show the amounts and sources of income, as well as the dates received.
- Maintain separate records and a separate bank account for each business and for personal transactions to identify income that derives from your business vs. personal income. A separate business account also makes it easier to reconcile business financial activity between the bank and your financial records.
- Documents that the IRS will accept to support business expenses include canceled checks, credit card sales slips, and vendor invoices:
- Check payments should be recorded in the financial records to include the check number, amount, payee’s name, date, and business purpose.
- Electronic funds transfer payments must show the amount transferred, the payee’s name, the date the transfer was posted by the financial institution, and the business purpose of the expense.
- Credit card payment support consists of the statement showing the amount charged, payee’s name, and transaction date. The business purpose must be noted in the financial records.
- Expenses for “mixed use” assets, such as vehicles, computers, and cell phones, must be allocated between business and personal use. Use an automated or manual log to track the use of the asset and maintain the log as support documentation.
Dedicating so much IRS Tax Forum time to business income and expense support reflects the topic’s importance. Don’t get caught short on support documents if the IRS asks questions about items reported on your income tax return. Maintain up-to-date financial records and all required support documents as you go throughout the year.