Use stat 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 of expenses as an allowed method of ascertaining your 100 percent deductible M&E expenses from your nondeductible and 50 percent deductible expenses.
Some specific details
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 statistical 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. Reviews now are of greater value to taxpayers because they are much more efficient, beneficial and nonintrusive to your organization.
Now more than ever, companies need to review their M&E expenses, policies and procedures not only for a tax benefit, but for compliance with the new M&E rules in effect after Dec. 31, 2017. Tax reform completely eliminates the employer tax deduction for substantially all directly paid or reimbursed business entertainment expenses; however, it may allow employers to deduct up to 50 percent of certain enumerated expenses. We understand that IRS regulations will be issuing specific guidance that should define “entertainment” specifically. These definitions are intentionally broad, but there are numerous exceptions to the general rule and certain meals and entertainment expenses may still be 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, as well as incorrectly be subject to the new full disallowance of entertainment, and the use of statistical sampling can be particularly beneficial to identify expenses that should be treated as 50 percent or 100 percent deductible, such as employee social M&E expenses. These and additional examples of fully deductible expenses include:
- Expenses treated as employee compensation.1
- Reimbursed expenses.2
- Expenses for recreational, social, or similar activities primarily for the benefit of employees.3
- Expenses for goods, services, and facilities made available by the taxpayer to the general public.4
- Expenses for goods or services which are sold by the taxpayer in a bona fide transaction for an adequate and full consideration.5
- Expenses includable in income of persons who are not employees.6
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 nondeductible and 50 percent deductible expenses from 100 percent deductible expenses to help minimize income taxes and to be in compliance with new M&E rules in effect for 2018 forward.
1 Code Sec. 274(e)(2)
2 Code Sec. 274(e)(3)
3 Code Sec. 274(e)(4)
4 Code Sec. 274(e)(7)
5 Code Sec. 274(e)(8)
6 Code Sec. 274(e)(9)