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Ron’s question:

Is entertainment still deductible? If not, where do I find it?

Linda’s answer:

This is a timely question since there have been significant changes. Starting in October 2020, the IRS disallowed a deduction for entertainment, amusement or recreation such as entertaining at night clubs, cocktail lounges, theaters, country clubs, sporting events and on hunting, fishing, vacation and similar trips.

Why does it matter?

Many credit analysts have routinely subtracted the deductible meals and entertainment when determining cash flow of an entity, whether filing Schedule C or F on a 1040, or filing a 1065, 1120 or 1120S. This was a quick and easy way to capture the 50% that was not deductible. That will not work under the new rules.

When does it matter?

It doesn’t if the amount spent on meals and entertainment is not significant. In that case, make the adjustment or not. It just will not change your result that much.

It matters if entertainment is a significant expenditure for the company. Or if meals is significant and they meet the updated, and possibly temporary, rules for 100% deductibility of meals in some cases.

What are the relevant rules now?

Entertainment, recreation and amusement deductions are not allowed.

Business meals are still, generally, 50% deductible.

The cost of food and beverages (meals) provided during a recreational event are now 100% deductible (up from 50%) if the meals are purchased separately at the entertainment venue or the food and drink expense is listed separately from the cost of entertainment, the amount is not lavish or extravagant and the taxpayer or employee is present at the time of consumption.

A special (possibly temporary) benefit for restaurants

To help out restaurants during the pandemic, food and beverages are 100% deductible if purchased from a restaurant in 2021 and 2022. As is always the case with these types of deductions, the meal cannot be ‘lavish’ and an employee must be present.

What do we recommend for a 1040 analysis?

If the amount of deducted meals in not significant and the type of business is not likely to spend a lot on entertainment, I would stick with your current practice related to subtracting the deducted meals under the assumption that it is 50% and entertainment is not significant.

If the type of business is one that may spend significant amounts on entertainment, like a law firm serving high net worth and high income clients, I would ask how much they spent. A financial statement for the same period should show it.

What do we recommend for an 1120, 1120S or 1065 analysis?

If the entity has sufficient revenue or assets that they are required to provide a Schedule M-1, you will be able to see the amount of nondeducted meals and entertainment. Go ahead and subtract it as you have been doing. Most analysts subtract all nondeducted expenses that are not noncash (depreciation, amortization) and, if doing projected cashflow, are recurring.

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Linda Keith, CPA

Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis.
She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans.
Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.