Meals and Entertainment Deductions after Tax Reform Examples

The Tax Cuts and Jobs Act does not specifically address the deductibility of expenses for business meals.

The Department of the Treasury and the Internal Revenue Service intend to publish proposed regulations which will include guidance on the deductibility of them, but until then, here are some examples provided by IRS Notice 2018-76:

Example 1:

Taxpayer A invites B, a business contact, to a baseball game. A purchases tickets for A and B to attend the game. While at the game, A buys hot dogs and drinks for A and B.

The baseball game is entertainment as defined and, thus, the cost of the game tickets is an Entertainment expense and is not deductible by A. The cost of the hot dogs and drinks, which are purchased separately from the game tickets, is not an entertainment expense. Therefore, A may deduct 50 percent of the expenses associated with the hot dogs and drinks purchased at the game.

 

Example 2:

Taxpayer C invites D, a business contact, to a basketball game. C purchases tickets for C and D to attend the game in a suite, where they have access to food and beverages. The cost of the basketball game tickets, as stated on the invoice, includes the food and beverages.

The basketball game is entertainment as and, thus, the cost of the game tickets is an entertainment expense and is not deductible by C. The cost of the food and beverages, which are not purchased separately from the game tickets, is not stated separately on the invoice. Thus, the cost of the food and beverages also is an entertainment expense. Therefore, C may not deduct any of the expenses associated with the basketball game.

 

Example 3:

Assume the same facts as in Example 2, except that the invoice for the basketball game tickets separately states the cost of the food and beverages.

As in Example 2, the basketball game is entertainment and, thus, the cost of the game tickets, other than the cost of the food and beverages, is an entertainment expense and is not deductible by C. However, the cost of the food and beverages, which is stated separately on the invoice for the game tickets, is not an entertainment expense, C may deduct 50 percent of the expenses associated with the food and beverages provided at the game.

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Meals and Entertainment Deductions after Tax Reform

The Tax Cuts and Jobs Act generally disallows a deduction for expenses with respect to entertainment, amusement, or recreation. However, the Act does not specifically address the deductibility of expenses for business meals.

The Department of the Treasury and the Internal Revenue Service intend to publish proposed regulations which will include guidance on the deductibility of:

-expenses for certain business meals

-expenses for food and beverages furnished primarily to employees on the employer’s business premises

-when business meal expenses are nondeductible entertainment expenses and when they are 50 percent deductible expenses

 

The Act generally disallows a deduction for any item of an activity that is of a type generally considered to constitute entertainment, amusement, or recreation.  It generally provides that no deduction is allowed for the expense of any food or beverages unless:

(A) such expense is not lavish or extravagant under the circumstances, and

(B) the taxpayer (or an employee of the taxpayer) is present at the furnishing of such food or beverages

 

“Entertainment” means any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacation, and similar trips, including such activity relating solely to the taxpayer or the taxpayer’s family.

 

“Entertainment” may include:

-a hotel suite, or an automobile to a business customer or the customer’s family

-providing of a hotel room or an automobile by an employer to an employee who is on vacation

 

“Entertainment” does not include:

-supper money provided by an employer to an employee working overtime

-hotel room maintained by an employer for lodging of employees while in business travel status

-automobile used in the active conduct of trade or business even though also used for routine personal purposes such as commuting to and from work

 

The Act clarifies that taxpayers generally may continue to deduct 50 percent of the food and beverage expenses associated with operating their trade or business. Taxpayers may still deduct 50 percent of an allowable business meal expense if:

  1. The expense is an ordinary and necessary expense paid or incurred during the taxable year in carrying on any trade or business;
  2. The expense is not lavish or extravagant under the circumstances;
  3. The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
  4. The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
  5. In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts.
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Vacation, Holiday, and Overtime Pay

Holidays

This may come as a surprise, but federal law does not require employers to pay employees extra, or above normal pay, for working on a holiday.  The holidays are typically considered regular workdays and employees receive their normal pay for time worked.  The Fair Labor Standards Act (FLSA) requires employers to pay only for time worked.  However, many employers provide holidays off or extra pay for working on a holiday. These arrangements are considered employee benefits and are typically included in an Employment Contract.

 

Overtime

Also, under federal law, a holiday doesn’t have a special designation for overtime pay nor is working on a holiday considered overtime. Federal law views holidays as just another business day.  Under federal law, overtime is calculated weekly. This means if an employee works over 40 hours during the week of typical paid holidays, they are entitled to “time and a half” for the hours worked over 40 hours.

 

Vacation

One other point, federal law does not provide for vacation pay. Under the FLSA, employers are not obligated to pay employees for time not worked including vacation days and holidays. Therefore, if an employee takes a vacation day on a holiday, there is no law requiring them to be paid for the time off.

If an employee is entitled to vacation pay, it is based on an agreement between the employer and the employee.

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The New 1040

The IRS is working on a draft version of the 2018 Form 1040, U.S. Individual Income Tax Return.  It reduces the size of the form to two half-pages in length and eliminates more than 50 lines.

The 2018 draft form uses the first page to gather information about the taxpayer and any dependents. The second page gathers information on the taxpayer’s income, deductions, credits, and taxes paid.

The other items reported on the 1040 will be calculated on various new schedules, which have also not yet been officially posted. They include:

Schedule 1: Additional Income and Adjustments to Income –

such as business income, alimony received, capital gain or losses, and adjustments including educator expenses and student loan interest expense.

Schedule 2: Tax –

such as the tax on a child’s unearned income (commonly called the kiddie tax), the alternative minimum tax, and any excess premium tax credit that must be refunded.

Schedule 3: Nonrefundable Credits –

such as the foreign tax credit, the credit for child and dependent child care, the education credit, and the residential energy credit.

Schedule 4: Other Taxes –

such as household employment taxes, the health care individual responsibility payment, the net investment income tax, and the additional Medicare tax.

Schedule 5: Other Payments and Refundable Credits –

such as estimated tax payments, the net premium tax credit, and amounts paid with an extension request.

The draft Form 1040 refers to various existing schedules including;

Schedule A – Itemized Deductions

Schedule C – Profit or Loss From Business

Schedule D – Capital Gains and Losses

Schedule E – Supplemental Income and Loss

Schedule F – Profit or Loss From Farming

Schedule H – Household Employment Taxes

Schedule SE – Self-Employment Tax

Schedule 8812 – Child Tax Credit

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Should I borrow from my 401(k) plan? When it Works

Borrowing from a 401(k) plan can make sense when cash is needed for a serious SHORT-TERM liquidity need.  “Short-term” is roughly a year or less.  “Serious liquidity need” does NOT include a sudden yearning for a flat-screen TV.

The best time to take a loan is when the stock market might be vulnerable or weakening (such as during recessions). Coincidentally, many people find that they need short-term liquidity during such periods.

When a borrower takes a 401(k) loan for appropriate amounts of money for the right SHORT-TERM reasons, these loans can be simple, convenient and low-cost. Before taking any loan, a borrower should always have a clear plan in mind for repaying these amounts on schedule or earlier.

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Should I borrow from my 401(k) plan? Purchase a Primary Residence

Regulations require 401(k) plan loans to be repaid on an amortizing basis over not more than five years, unless the loan is used to purchase a primary residence. Longer payback periods are allowed for these particular loans.

Evaluating the use of 401(k) plan loans for home purchases is complex, and plan loans may not be as attractive as mortgage loans. Plan loans do not offer tax deductions for interest payments as do most types of mortgages, home-equity loans and home-equity lines of credit. The impact on retirement progress for a loan paid back over many years can be significant. It is best to consult personal tax and financial advisors before taking such loans.

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Should I borrow from my 401(k) plan? The upside

Sometimes it may make sense to borrow from your 401(k) plan.  The upsides are:

–401(k) loans can be a quick, simple, lowest-cost way to get cash needed.

–In most 401(k) plans, requesting a loan requires no lengthy applications or credit checks nor does it affect credit rating.

–If the loan is short-term loan and paid back on schedule, it usually will have little impact on retirement savings progress. In some cases, it can have a positive impact.

–Borrowers avoid any investment losses on this money.  A loan can be neutral, or even positive, in sideways or down markets.  If the interest paid in exceeds any lost investment earnings, taking a 401(k) loan actually can increase retirement progress.

–Receiving a loan is not a taxable event unless the loan limits and repayment rules are violated.

–Many 401(k)s allow loan requests to be made through a website with the amount received in a few days with total privacy.

–Some plans now offer a debit card through which multiple loans can be made instantly in small amounts.

–Most 401(k) loans can be repaid faster than the loan schedule with no prepayment penalty.

— Most plans allow loan repayments to be made through payroll deductions (using after-tax dollars).

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Should I borrow from my 401(k) plan? The Pitfalls

The pitfalls of borrowing from a 401(k) plan are the following opportunity costs:

–Borrowers lose any positive earnings that would have been produced by those investments in the market.  In other words, the impact is negative in strong ‘up’ markets.

–Many borrowers either stop contributing to their 401(k) or reduce their contribution for the duration of their loan, so they also miss out on the company match.

–Unless the money is repaid quickly, the loan represents a permanent setback to retirement planning.

–Borrowers lose out on tax efficiency. Loans are repaid with after-tax dollars. In other words, someone in the 25% tax bracket would need to earn $125 to repay $100 of the loan. The 401(k) money is taxed again when withdrawn in retirement, so those who take out a loan are subjected to double taxation.

— Double taxation of 401(k) loan interest becomes a meaningful cost when large amounts are borrowed and then repaid over multiyear periods.

–The first 401(k) loan can act as a “gateway” to serial borrowing.

–The interest borrowers save by choosing a 401(k) loan over a bank loan still might not be enough to make up for the loss of earnings from taking the money out of the 401(k) account.

–There may be a loan origination or administration fee to tap into a borrower’s own 401(k) money.

–A 401(k) loan can become a serious problem without having the intent or ability to repay it on schedule. In this case, the unpaid loan balance is treated similarly to a hardship withdrawal with negative tax consequences and perhaps also an unfavorable impact on plan participation rights.

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Should I borrow from my 401(k) plan? The Basics

According to a study by the Employee Benefits Research Institute (EBRI), nearly 20% of all 401(k) participants had plan loans outstanding. This statistic has held true since the early 2000s.  These loans can be appropriate in some situations.  However, borrowing from a 401(k) plan exacts a big opportunity cost.  Let’s first look at what borrowing from a 401(k) plan means and how it works.

Technically, 401(k) loans are more accurately described as the ability to access a portion of retirement plan money on a tax-free basis. A borrower then must repay the money accessed to restore the 401(k) plan to its original state.

Borrowers specify the investment account(s) from which to borrow money. Those investments are liquidated for the duration of the loan.

As loan repayments are made to the 401(k) account, they usually are allocated back into the investments originally chosen. The account is repaid more than what was borrowed from it, and the difference is called interest.

Any interest charged on the outstanding loan balance is repaid by the participant into the participant’s own 401(k) account, so technically this is a transfer from one pocket to another, not a borrowing cost.

Regulations specify a five-year amortizing repayment schedule.  Repayment plan statements show credits to the loan account and remaining principal balance, just like a regular bank loan statement.

If a 401(k) is invested in stocks, the impact of the loan on retirement progress depends on the market environment.

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Ever-Changing Tax Law

There were about 4,430 changes to the tax code from 2001 through 2010, an average of more than one a day.

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