New Clarity on M&E Deductions Give a Little Wiggle Room

On September 29, 2020, the IRS published the long-awaited final regulations on the deductions for meals and entertainment (“M&E”) expenses. While the final regulations are largely similar to those proposed earlier this year, there are some key changes and clarifications that could impact your company’s bottom line if you have historically taken advantage of M&E deductions.

The Basics of M&E Deductions

When Congress passed the TCJA in 2017, it significantly limited the tax benefits available to companies for M&E expenses by eliminating deductions for business entertainment expenses and reducing the deductible amount for certain categories of meals.

Under the current legislation, these are the M&E deductions your company may be eligible for:

• 50% deduction for the expense of meals with coworkers, clients, customers, or external employees
• 50% deduction for the cost of meals purchased separately from entertainment
• 50% deduction for meal expenses such as break room snacks and overtime meals
• 50% deduction for meals provided for the convenience of the employer (until 2025, after which such meals will no longer be deductible at all)
• 100% deduction for recreational expenses, like holiday parties and team-building events
• 100% deduction for food and beverage made available to the general public

We discussed these changes at length in a previous article after the IRS issued the proposed regulations in February 2020, but additional commentary from the public since then has prompted further revision, as detailed in the new final regulations.

What’s New in the Final Regulations

Although the final regulations are not substantially different from what was proposed in February, they do include one helpful clarification and one crucial revision that companies should be aware of.

1. Clarifications on the definition of a “business associate” – The final regulations first clarify that food and beverages provided to employees may be included as deductible expenses, as an employee can represent an allowable “business associate.” The regulations also provide some specific examples to define the deductibility of food and beverages as clearly as possible, which may be especially useful for taxpayers in light of the increase of virtual meetings due to the pandemic. While the regulations failed to explicitly address how to treat food and beverage expenses provided to clients for virtual meetings, an employee’s virtual presence in a meeting appears to satisfy the employee presence requirement for food and beverage expense deduction.
2. Changes to the exceptions for meals included in compensation – Under the proposed regulations, taxpayers were required to fully include the cost of meals in employee or non-employee compensation to satisfy requirements for full deduction of the related food and beverage expenses. Under the final regulations, taxpayers can use a dollar-for-dollar approach and fully expense only the portion of expenses that is included in compensation rather than the previously proposed “all or nothing” methodology to meet the limitation exception.
3. New documentation requirements – The final regulations also clarify taxpayers’ reporting requirements when claiming an M&E deduction. Taxpayers claiming an M&E expense for a qualifying event must report the meals portion of the expense separately from the entertainment event. Any taxpayer who fails to do so will have their deductions disallowed. The key to benefiting from M&E deductions under the new tax law and regulations heavily depends on proper documentation and reporting.

Maximizing your Benefit Under a More Restrictive Tax Law

Even considering these slightly relaxed final regulations, the TCJA has still reduced many taxpayers’ M&E deductions by a significant amount. It is more important than ever to maximize your potential benefit.

The most critical step your business can take is to assess your M&E expenses and prepare your substantiation. We previously provided some useful tips on how to categorize these expenses and understand what is (and is not) deductible. Correctly categorizing and substantiating your expenses is your first and most powerful line of defense in avoiding fines and identifying every possible deduction.

Bottom line

Many businesses took a hit when the rules for M&E deductions changed in 2017, but the final regulations provided long-awaited clarity and even some additional flexibility in calculating these deductions.

If your business has historically benefited from M&E deductions, or if you think you have potential eligible deductions now, it is best to work with a knowledgeable tax advisor. Aprio has been closely following the changes to M&E deductions since the legislation first passed, and we’re prepared to help you maximize your benefit.

Contact Meredith Kowal, Partner, for more information.