You likely have heard conflicting information on the deductibility of business meals with clients and prospects.
I have spent time researching this issue, and my conclusion is that tax reform eliminated tax deductions for business meals with clients and prospects.
Before enactment of the Tax Reform Act of 1986, the business meal requirement, according to the Joint Committee on Taxation’s Blue Book, allowed what we called 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 three things to client and prospect meals:
- Reduced tax deductions for meals from 100 to 80 percent
- Required you to establish that the meal was directly related to or associated with the active conduct of your business
- Required you to substantiate that you had a substantial and bona fide business discussion during, directly preceding, or directly following the meal
The Tax Cuts and Jobs Act repealed all the requirements above, effective January 1, 2018.
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.
Here are some examples of the way we see business meals after tax reform:
- Sam owns a tax practice and takes Silvia, a prospect, to lunch and pays for the two of them. Now, because of tax reform, this lunch is not deductible.
- Sara and Jim are both dentists in private practice. They go to dinner to discuss a new piece of equipment that could benefit their practices. They each pay for their own meal. They get no deductions. Because of tax reform, Dutch-treat business meals are no longer deductible.
- Fred takes a client of many years out to dinner to help him with his business plans for this year. They review the plans in detail. The client picks up the tab. Fred’s client may not deduct the business meal.
To see the changes in a technical way, let’s review what tax reform did to make the business meal not deducible:
- Removed directly related and associated entertainment from IRC Section 274(a)
- Removed entertainment from the substantiation expense requirements of IRC Section 274(d)
- Removed Section 274(n)(1) from the tax code. This section applied the 50 percent rule to entertainment