Use statistical sampling to increase meals and entertainment deductions
Additional deductions can reduce effective tax rate and increase cash
INSIGHT ARTICLE |
Until fairly recently, it has been a tedious and time-consuming task to identify whether your company is deducting the full meals and entertainment (M&E) expenses available. Now, statistical sampling has brought ease to the process through extrapolation to three years of expenses as an allowed method of ascertaining your 100 percent deductible M&E permanent expenses.
Previously, M&E reviews consisted of reviewing thousands of expenses and only taking a deduction for the specific amounts reclassified on the face of the transaction. For example, a $25 employee picnic only represents a $25 deduction without sampling. However, now with stat sampling pursuant to Rev. Proc. 2011-42, the review is only of a limited number of expenses to arrive at a correction percentage which is extrapolated to your entire M&E balance. Our experience has shown that an M&E study using statistical sampling yields, on average, a 30 percent increase in M&E deductions. Accordingly, with sampling, the same $25 employee picnic may represent a $1,000 deduction through extrapolation of sampling. In addition, your benefit increases exponentially because one sample can be used to increase deductions for 3 prior tax years. Reviews now are of greater value to taxpayers because they are much more efficient, beneficial and non-intrusive to your organization.
The Internal Revenue Code states that, "in general," a taxpayer may only deduct 50 percent of meals and entertainment expenses. "Meals" are defined as food or beverages, and "entertainment" is defined as "any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such activity"1. These definitions are intentionally broad, but there are numerous exceptions to the general rule and certain meals and entertainment expenses are 100 percent deductible.
Companies that do not review the tax treatment of their M&E expenses fail to realize the exceptions to the 50 percent rule, and the use of stat sampling can be particularly beneficial to identify expenses that should be treated as 100 percent deductible, such as employee social M&E expenses and employee de minimis fringe benefits. These and additional examples of fully deductible expenses include:
- Expenses treated as employee compensation.2
- Reimbursed expenses.3
- Expenses for recreational, social, or similar activities primarily for the benefit of employees.4
- Expenses for goods, services, and facilities made available by the taxpayer to the general public.5
- Expenses for goods or services which are sold by the taxpayer in a bona fide transaction for an adequate and full consideration.6
- Expenses includable in income of persons who are not employees.7
Through the use of statistical sampling, companies may efficiently increase earnings per share, decrease their effective tax rate and increase cash by incorporating these rules into their accounting policies and may non-intrusively segregate 50 percent deductible expenses from 100 percent deductible expenses to help minimize income taxes.
1 Code Sec. 274(n)(1)
2 Code Sec. 274(e)(2)
3 Code Sec. 274(e)(3)
4 Code Sec. 274(e)(4)
5 Code Sec. 274(e)(7)
6 Code Sec. 274(e)(8)
7 Code Sec. 274(e)(9)