March 12, 2018 What asset managers need to know to comply with new meal and entertainment expensing provisions The recently enacted "Tax Cuts and Jobs Act" (H.R.1, TCJA) changed the tax treatment of meals and entertainment (M&E) expenses, as well as some employee fringe benefits. This Alert highlights the changes of interest to management companies in the private equity (PE) and alternative asset management industry. Meals and entertainment The TCJA significantly changed a company's ability to deduct M&E expenses. Generally, the TCJA completely eliminated an employer's ability to deduct entertainment expenses (even if those expenses were for business reasons). The TCJA also significantly limited an employer's ability to deduct expenses associated with de minimis meals, including meals provided at an employer-operated eating facility, or meals provided for the convenience of the employer. Meals Prior law Prior law permitted taxpayers to deduct 50% of meal expenses that were ordinary, necessary and directly related to the active conduct of the taxpayer's trade or business. Additionally, the law permitted employers to deduct 100% of the cost of: (1) meals provided in an employer-operated eating facility (i.e., an employer-operated cafeteria); (2) other de minimis meals provided to employees (e.g., snacks and overtime meals); and (3) qualified meals provided for the convenience of the employer (i.e., free meals) if provided in an employer-operated eating facility. For further discussion of the prior law treatment of meal expenses, see Tax Alert 2018-143. Current law Effective January 1, 2018 through December 31, 2025, the TCJA effectively imposes a 50% limitation on the deduction of expenses for: (1) food or beverages provided in an employer-operated eating facility, including meals provided for the convenience of the employer at the facility, and (2) de minimis meals. Effective for expenses incurred after December 31, 2025, no deduction is allowed for: (1) any expense for operating an employer-operated eating facility; (2) food or beverage expenses associated with that facility; or (3) expenses for meals provided for the convenience of the employer. For additional discussion of this change, see Tax Alert 2018-143. Practical applications of the new law 1. Taxpayer takes a client to a dinner and sporting event (for example, a round of golf with a meal). Outcome: The cost of the sporting event is a nondeductible entertainment expense. The meal expense is also not deductible unless the taxpayer can prove that the meal was a separate expense that was not an entertainment expense. Since there is no guidance on bifurcating meal and entertainment costs, the conservative position is to disallow the entire amount associated with an entertainment event, including meals. 2. Taxpayer's employees go out to lunch to discuss the marketing of a new tool and discuss business over lunch. Outcome: Employee business meals are eligible for a 50% deduction. 3. Taxpayer provides lunch to all employees to avoid disruptions in work flow (or employees order via a website and pay with company credit card, under Taxpayer's direction). Outcome: Taxpayer may deduct 50% of the cost of these meals from January 1, 2018 to December 31, 2025; effective January 1, 2026, these costs are not deductible to the extent the meals are provided for the employer's convenience. 4. Taxpayer provides pantry items such as coffee, water snacks, etc. on its premises. Outcome: These expenses are 50% deductible. 5. Taxpayer pays for drinks/snacks for a segment of its employees (e.g., the finance department, the human resources team), such as an outing, happy hour, or other social event and a similar event is available for all segments of employees/ departments at their chosen time. Outcome: These expenses may generally be 100% deductible as employee recreational expenses, if offered on a non-discriminatory basis. 6. Taxpayer provides meals that are consumed at annual events open to all employees, such as holiday parties, picnics, etc. Outcome: Taxpayer may deduct 100% of the cost as a non-discriminatory recreational expense for employees. 7. A partner goes to lunch with a peer to discuss investment ideas. Outcome: Generally, 50% of the cost is deductible as a business meal expense. 8. An employee consumes meals while traveling. Outcome: Taxpayer may deduct 50% of the cost (provided the meals are not an entertainment expense). 9. Taxpayer consumes a meal with a client, on or off its premises, while discussing business. Outcome: Taxpayer may deduct 50% of the cost (provided the meals are not an entertainment expense). Caution The burden of proof is on a taxpayer to establish that a business meal is a separate expense from an entertainment expense. Currently, there is no guidance on how to bifurcate these expenses. If a meal is an entertainment expense, the meal will not be deductible. Business entertainment Prior law Previously,1 Section 274 disallowed an otherwise permitted deduction for expenses related to meals, entertainment, amusement or recreational activities, or facilities (including membership dues), unless those expenses were directly related to the active conduct of the taxpayer's trade or business. If a taxpayer could demonstrate that those expenses were directly related to its trade or business, the taxpayer could deduct up to 50% of the M&E expenses. Current law Effective January 1, 2018, the TCJA modifies Section 274 by making all entertainment expenses, including facilities used for entertainment activities, nondeductible, even if these expenses directly relate to, or are associated with, the conduct of business. Business meals and beverages, however, remain 50% deductible. Hence, all forms of business entertainment, including golf outings, fishing, sailing, sporting events, hunting, theater, and associated expenses, such as license fees paid to sporting arenas or golf club dues, are entirely nondeductible, even if a substantial and bona fide business discussion is associated with the activity. There are certain expenses eligible for exception from the entertainment disallowance, such as expenses for recreational, social, or similar activities (including facilities) primarily for the benefit of employees; this exception, however, is extremely limited. For additional discussion of this change, see Tax Alert 2018-143. Practical applications of the new law 1. Taxpayer hosts a holiday party or company picnic for employees. Outcome: Taxpayer may deduct 100% of the expense, provided the event is open to all employees. 2. Taxpayer holds team-building events for different segments of its employees (e.g., the administrative assistants, the tax department). The events do not discriminate in favor of highly paid employees Outcome: The expense is 100% deductible. Transportation Prior law Businesses could deduct payments (or employee elections to use pre-tax salary reduction from wages) for qualified transportation fringe benefits, and exclude the benefit from employees' gross income. The qualified transportation fringe included qualified van pools, qualified parking at or near a work location, transit benefits and qualified bicycle reimbursements. Current law Effective January 1, 2018, the value of a qualified transportation fringe benefit provided by an employer is still excluded from an employee's gross income, subject to monthly limits, except for qualified bicycle commuting reimbursements. However, the employer's deduction for the expenses of qualified transportation fringes or for any payment or reimbursement of expenses for travel between the employee's residence and place of employment will be disallowed, except if necessary to ensure the safety of an employee. (The disallowance of an employer deduction does not apply to bicycle commuting benefits for expenses incurred from January 1, 2018 to December 31, 2025). The qualified transportation fringe includes: 1. Transportation in a commuter highway vehicle for travel between the employee's residence and place of business 2. Transit passes 3. Qualified parking 4. Qualified bicycle commuting reimbursement Business transportation expenses remain 100% deductible for the employer. Practical implications Businesses need to assess their employee travel policies, specifically how they define "safety." Issues to consider include: (1) is travel to neighborhoods considered less safe; and (2) is travel anywhere after certain time, presumably at night, considered less safe? As there is no specific guidance, taxpayers need to clearly define these points in an internal policy statement. Employee achievement awards Prior law Section 74(c) and 274(j) provided an exclusion from income and wages and permitted a deduction, respectively, for certain employee achievements awards for up to $400 per employee per year if there was no qualified plan and up to $1,600 with a qualified plan (with an average award not exceeding $400 per employee) with certain other limitations applying. For these purposes, "an employee achievement award" means an item of tangible personal property that is transferred by an employer to an employee for length of service or safety achievement that is awarded as part of a meaningful presentation and under conditions that do not suggest that the award is disguised compensation. Neither Code section defined tangible personal property, but proposed regulations issued in 1989 and sub-regulatory IRS guidance provided that tangible personal property does not include cash, or a certificate, vacations, meals, lodging, tickets, etc. Current law The TCJA did not modify the amount of the employer's deduction but rather clarifies cash or cash equivalents and a list of other items that do not qualify as "tangible personal property" for purposes of income exclusion or deduction. Specifically, for purposes of an employee achievement award, the term "tangible personal property" does not include cash or cash equivalents, gift cards, gift coupons, gift certificates or vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, or other similar items. Arrangements that confer only a right to select and receive tangible personal property from a limited array of items pre-selected or pre-approved by the employer qualify as tangible property. The TCJA provisions are very similar to sub-regulatory IRS guidance and the 1989 proposed regulations. Practical applications of the new law For an employee's 15th employment anniversary, Taxpayer, after a meaningful presentation, gives the employee access to a website from which she may select gift items. Available gifts include jewelry and watches, kitchen accessories, sporting equipment, and other tangible items. Gift cards, sporting or theater tickets, and vouchers for travel or lodging are not available. Outcome: The award meets the definition of tangible personal property as previously described and therefore should be deductible. ———————————————
———————————————
——————————————— 1 For purposes of this Alert, references to "prior law" means the law that was in effect for expenses paid or incurred prior to January 1, 2018. | ||||||||||||||||||||||
| ||||||||||||||||||||||
