The Tax Cuts and Jobs Act (TCJA) provided the most substantial overhaul of the U.S. tax code in decades and sought to further limit the deductibility of some meals and most entertainment expenses, but some important exceptions still apply. The deductibility of many popular employer- provided fringe benefits, such as deductions for work-related activities—including certain meal and entertainment expenses have undergone sweeping changes. Now more than ever, employers need to understand their M&E expenses and ensure they are properly categorized and deducted, to avoid lost tax savings.
Now, business meals and most entertainment expenses are either non-deductible or 50 percent tax deductible and as a result, companies should bifurcate these expenses in their general ledgers so they are easily identified at tax time. What many companies fail to realize is that there are still numerous exceptions to the full disallowance and 50 percent deduction rules. These exceptions can be particularly beneficial to certain industries, such as government contracting companies. M&E expenses that are 100 percent deductible, include:
- Expenses treated as 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
Government contractors with cost reimbursable-type contracts should pay particular attention to the "reimbursed expenses" exception of Code Section 274(e)(3). The regulations under section 274 state that, in the case of an expense for meals or entertainment of an independent contractor in performing services for a customer under a reimbursement arrangement, the 50 percent limitation applies to the party expressly identified in an agreement between the parties as subject to the limitation.8 If an agreement between the parties does not expressly identify the party subject to the limitations (as is generally the case), the 50 percent limitation applies either:
- To the independent contractor to the extent the independent contractor does not account for the expenses to the customer.9
- To the customer if the independent contractor accounts for the expenses to the customer.10
Under cost reimbursable-type contracts, contractors are reimbursed for expenses incurred, and they must be able to substantiate their costs to the government. The rules for reimbursement of government contractor's expenses under cost reimbursable-type contracts are contained within the Federal Acquisition Regulations (FAR). According to the FAR, costs for transportation, lodging, meals, and incidental expenses incurred by a contractor personnel on official company business are reimbursable, and reimbursement can be based on actual expenses or per diem rates, provided the method used results in a reasonable charge. Costs will be considered reasonable and allowable only to the extent that they do not exceed on a daily basis the maximum per diem rates in effect at the time.11 Government contractors typically use per diem rates to avoid running afoul of the reimbursement rules in the FAR.
To summarize, government contractors who incur meals and entertainment expenses that are reimbursed under cost reimbursement-type contracts are exempt from the 50 percent deduction limitation for the reimbursed expenses. Government contractors should incorporate these rules into their accounting policies and take care to segregate fully disallowed and 50 percent deductible expenses from 100 percent deductible expenses to help minimize income taxes.
