The major changes to entertainment and meal expense deductions brought about by the Tax Cuts and Jobs Act (TCJA) in 2017 may be a distant memory for many freelancers, but the IRS is still in the process of finalizing them, a move that may impact your tax obligations.
The original guidance under the TCJA essentially eliminated the deductions for entertainment expenses but still allowed businesses to deduct expenses related to food and beverages within certain parameters. The final regulations reintroduce some limited deductions for entertainment, amusement, and recreation activities. In addition, the IRS is providing additional information on what exactly constitutes an entertainment expense and the limitations on food and beverage expenses.
This guidance applies for expenses incurred after December 31, 2017. Under the TCJA, if they are incurred and paid after Dec. 31, 2025, they will not be deductible at all.
These are the key clarifications from the final regulations issued by the IRS that may impact freelancers:
· Certain recreational activities for the benefit of employees, reimbursed expenses, and entertainment treated as compensation to an employee or includible in the gross income of a nonemployee as compensation for services or as a prize or award (and reported by the taxpayer as such) are still eligible entertainment expenses.
· The 50% limit of deductibility of food or beverages still remains in the final guidelines, along with the provision that these expenses must be reasonable and moderate (as opposed to lavish and extravagant), and such refreshments should be served with the mindset of them being offered as part of an ordinary business expense.
· In addition, the taxpayer (i.e., you as a freelance business owner) or an employee of the taxpayer must be present when food or beverages are served.
· The TCJA also applied the 50% limitation on food or beverages to de minimis fringe employee benefits, small-value employee perks like bringing in coffee and doughnuts or paying for dinner when someone works overtime. These were previously fully deductible.
· You must separate deductible meal expenses from nondeductible entertainment expenses in order to report and deduct them correctly from your taxes.
Another important point stated in the IRS' final rule is that any food and/or beverages you deduct must be able to be proven to have been provided to “a person with whom the taxpayer could reasonably expect to engage or deal in the active conduct of the taxpayer’s trade or business such as the taxpayer’s customer, client, supplier, employee, agent, partner, or professional adviser, whether established or prospective.” (In other words, you can’t dine alone to get the deduction.) The above definition is also applied to employer-provided food or beverage expenses in the final rule which defines employees as being business associates if meals are provided at the same event to both employees and nonemployee business associates.
While the current pandemic may have curtailed much of your client entertaining and dining out this year, it is still important to understand these final rules. Keep your receipts in order so you have the documentation needed to reduce your tax bill as much as possible. And be aware that this final rule applies not only to this tax year, but to 2018 and 2019, if you need to file those returns late or amend them.
Jonathan Medows is a New York City–based CPA who specializes in taxes and business issues for freelancers and self-employed individuals across the country. He provides tax, accounting and business articles for freelancers on his website, http://www.cpaforfreelancers.com, which also features a blog and a comprehensive freelance tax guide. Please note, due to the high volume of inquiries in regard to COVID-19, Jonathan is not able to respond to individual requests for information at this time.