Taking Another Tax Bite Out of Meal and Entertainment Expenses
A few tax incentives your firm can chew on.
January 27, 2011
As we enter the corporate tax filing season, one area of discussion with corporate and individual clients is the non-deductibility or partial deductibility of certain meals, entertainment and other related expenses.
The realization that these expenses may offer less-than-expected tax advantage can be a surprise and source of frustration to certain taxpayers due to increased taxable income, decreased cash-flow and increases in effective tax rates.
Fortunately, there are a number of exceptions to these general expense disallowance rules that can allow taxpayers to deduct the full meal-and-entertainment expenditure on their federal and many state tax returns.
Certain industries, such as professional service organizations, companies with multistate or international operations and organizations with large sales forces, can incur significant meals-and-entertainment expenditures. While most businesses will break out meals and entertainment expenses by department and/or general type of expense (e.g. meals, memberships, dues, etc.), corporations typically do not provide their CPAs with a level of detail of these expenses to allow a full analysis. This can result in over-, or more likely, under-deducting these expenses for tax purposes. Therefore an enhanced chart-of-accounts will improve tax classifications.
IRC Section 274(a)(1) states that no deduction is allowed for expenses associated with expenditures or facilities associated with "entertainment, amusement or recreation," unless the taxpayer can support that the expenditure was directly related to a bona fide business discussion, business meeting or business convention. IRC Section 274(a)(1)(B) requires an allocation between deductible business and non-business expenses of facilities costs when there is mixed use. IRC Section 274(c) and (h) detail the foreign travel and convention deductibility rules that can generate significant add-backs to taxable income.
IRC Section 274(d) and Treas. Reg. Section 1.274-5 also provide for full disallowance of meals, entertainment and lodging expenses unless the taxpayer documents for each expenditure in excess of $75:
IRC Section 274(a)(2) and Treas. Reg. Section 1.274-2(a)(2) adds that no tax deduction will generally be allowed for membership payments for club dues, including dues to clubs organized for "business, pleasure, recreation or other social purpose." This regulation applies to country club dues, health clubs and pure social clubs. Treas. Reg. Section 1.274-2(a)(2)(iii)(b) carves out exceptions for full deductibility in those cases in which a taxpayer pays membership or ongoing dues to: "business leagues, trade associations, chambers of commerce, boards of trade, real estate boards, professional organizations and civic or public service organizations."
Once a taxpayer has navigated around the general business vs. non-business provisions in IRC Section 274(a), other provisions must be evaluated to determine whether an expenditure falls into one of the above-mentioned buckets.
Fifty Percent Meals and Entertainment Add-Back
IRC Section 274(n) applies a general 50-percent limitation on the deductible portion of "business related" meals and entertainment (other than the primarily non-deductible skybox expenditures and "event" tickets purchased at prices above the "face" amount on the ticket — IRC Section 274 (l)(2) and 275 (l)(1), respectively.
Interestingly, Form 1120, Page 5, Schedule M-1, Line 5.c. lists the 50-percent taxable income add-back as "Travel & Entertainment" vs. "Meals & Entertainment," further adding to the general taxpayer confusion as to which expenses are non-deductible, 50 percent deductible or fully deductible. Note: Lodging is generally fully deductible, with the exception of certain foreign or most cruise-based conventions/meetings [see IRC Section 274(h)].
Specific Exceptions Allowing Full Deductibility
IRC Section 274(e) and (n) provide a number of situations in which the 50 percent tax deduction scale-back will not be required. Following are the major exceptions that will allow the taxpayer to claim the full deduction:
Due to the lack of detailed accounting for myriad of business expenditure types, many taxpayers and CPAs simply end up adding back 50 percent of ALL meals and entertainment expenses for simplicity.
Accountable Plans Offer Flexibility and Tax Advantages
In dealing with funding employee meal and entertainment costs, many employers opt to simply provide their employees with a car or other expense allowance, with no requirement to account for the expenditures. Such arrangements are called "Non-Accountable Plans" under Treas. Reg. Section 1.62-2. All reimbursements made under these arrangements are subject to W-2 reporting and income and payroll taxes that are generally imposed.
One solution to maximize administrative flexibility and tax efficiencies for both employer and employee is to adopt an "Accountable Plan" as described in Treas. Reg. Section 1.62-2 (PDF) and IRS Publication 463. View Tax Advantaged 'Accountable Plans' for Employee Business Expenses for an in-depth discussion of Accountable Plans.
By setting up such a plan, the advanced and/or reimbursed amounts are generally not reported to the employees on their W-2 and the employees and do not have to pay payroll taxes on the funds.
Per Diem Meals and Lodging Allowances
For those businesses that prefer to further minimize the documentation process, rather than using an accountable plan for employees' local and out-of-town travel, employers may opt to use the IRS issued Per-Diem/Daily Meals and Lodging Allowance guidelines. Per-Diem rates generally eliminate the need for detailed employee reporting.
The Per-Diem Meals and Lodging allowances vary with location and sometimes with the time of the year. For 2011, the highest lodging rate is for New York City at $269 per day and the lowest IRS rate is $77 per day. The daily meal rate allowances range from $46 per day in many rural locations to $71 per day in many urban locations. An interactive tool can determine the per-diem meal and lodging allowance for different locations by month.
With proper accounting systems in place and a clearer understanding of these expense reimbursement rules, corporations can improve the tax-effectiveness for both the employee and the company, while improving cash-flow for all concerned.
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Blake Christian, CPA, MBT is a tax partner with Holthouse, Carlin & Van Trigt LLP and Co-Founder of National Tax Credit Group, Inc. He can be reached at (562) 216-1800.