The Hidden Entitlements
5. Business meals and entertainment
It's a fundamental (and usually honored) income tax principle that personal outlays, whether for a family car, a house, food or entertainment, shouldnot be deductible in computing net income.10 On the contrary, these are precisely the things that net income is used to buy. If the income tax laws generally allowed people to deduct their personal expenses, there would be little or nothing left to tax (except savings).11
To be sure, when taxpayers assert that some of their apparently personal outlays also have a business purpose, the issues are not always clear cut.Although the tax code ostensibly allows deductions only for "necessary"business expenses, this rule is liberally interpreted when a business purpose clearly predominates. The law does not limit deductions for office furnishings,for example, to the cheapest available.
But when the personal element of an outlay dominates, the tax code should not (and usually does not) allow a deduction. For example, although someone could reasonably say that he or she needs a place to live in order to survive(and be able to work), normal housing costs have no particular linkage to earning income, and are thus not deductible as business expenses. Likewise,commuting costs may make it possible to get to work, but they are properly treated as stemming from personal decisions about where to live, rather than being primarily business-related, and are thus not deductible.
It's hard to imagine any outlays that are more quintessentially personal than those for meals and entertainment. Everyone has to eat, no matter what their profession or trade (if any). Entertainment, by definition, is designed to provide personal satisfaction and enjoyment.
Current law recognizes that eating and entertainment expenses are personal when a person makes such outlays solely on his or her own behalf. The fact that someone may read a business journal over lunch or think about marketing strategies during a football game does not transform those meals and entertainment outlays into deductible business expenses. Strangely, however, when a meal or recreational activity is shared with a business associate or a potential client or customer, the tax law generally allows half of the amount spent to be written off.
Specifically, meals that bear a "reasonable and proximate relationship to a trade or business" are 50% deductible if they occur under circumstances that are "conducive to a business discussion." There's no requirement that business actually be discussed, either before, during or after the meal. Entertainment outlays are 50% deductible if the taxpayer has more than a general expectation of deriving income or a specific trade or business benefit (other than goodwill) from the activity, or more liberally, if the entertainment is directly preceded or followed by a substantial and bonafide business discussion (such as a business meal). Such a discussion does not have to occur on the same day as the entertainment, nor does it have to last as long.
The problem is not merely that these rules are hopelessly open to abuse--althoughof course they are. For example, a freelance writer may discuss virtually everything he writes with his wife, often over dinner. Indeed, most of their meals together may be "conducive to a business discussion" about writing projects. Should this couple be deducting the cost of those meals?If they go to a play or a sporting event after one of their "business meals," should their entertainment costs also be deductible? Would they be on firmer ground if they talked at an expensive restaurant about the wife's small-business projects, on which the husband often gives constructive advice?12
The fundamental problem is that no matter what the technical rules, the deduction for meals and entertainment is itself an abuse of good tax policy.Personal outlays of this sort simply should not be deductible in computing net income.
Analytically, the proper taxpayer in the case of meals and entertainment benefits should be the person who is fed or entertained. Thus, the theoretically correct treatment of such benefits would be to tax the recipients on the value of the benefits they receive. Denying deductions to payers, however,would produce roughly the same result, and would be considerably easier to administer.
Of course, in the case of self-employed people, denying a deduction for meals and entertainment personally enjoyed gives exactly the same answer as taxing the benefits. For employees, the issue is only slightly more complicated.Businesses can, of course, deduct the wages they pay their employees, whether paid in cash or in noncash compensation. But the employees are supposed to report those wages, cash or in-kind, as income on their personal tax returns. Thus, theoretically, employer payments to employees in the form of meals and entertainment could be deductible by employers and taxable to the employees. But a more workable solution is simply to deny the deductions to the employer. Because the relevant marginal tax rates on individuals and businesses are roughly the same, this approach gives about the same result as taxing the benefits to the employees.13
Customers of a business who receive meals and entertainment are in a similar position to employees. That is, the customers also receive in-kind income.Denying business deductions to the payer for those in-kind payments is a good, workable alternative to taxing those benefits directly to the recipients.
A perusal of testimony before the House Ways and Means Committee shows little effort by the proponents of the business meals and entertainment deduction to defend it on tax policy grounds. (Instead, they primarily talk about the need of their industries for government subsidies, a topic discussed below). But when a tax policy defense is raised for meals and entertainment write-offs, it usually comes down to arguing about the proper valuation of the benefits to the recipients.
In particular, defenders of the write-offs have asserted that the value of meals and entertainment received by self-employed people, employees,customers, spouses, etc. in a business context is often much less than the dollars spent. A salesman might not like fancy meals very much. Or a customer might not really be a hockey fan. Or a businessman might actually detest golf. They engage in these allegedly somewhat disagreeable activities, itis argued, only because of business necessity.14
This argument seems terribly weak. After all, the point of feeding and entertaining customers is to make them happy. Dragging customers to restaurants or stadiums that they abhor would hardly be a sound business practice. Likewise, those paying for meals and entertainment (or their employees) have substantial discretion in choosing where they eat or play.
As noted, defenders of write-offs for business meals and entertainment generally do not focus on tax policy issues. Instead, they attempt to defend the $6 billion annual cost of these deductions as government subsidies to the restaurant,resort and entertainment industries.
Now if one were to make a list of government spending priorities, a subsidy for business men and women's eating, drinking and entertainment would seem to be very near, if not at, the bottom of the list. (Perhaps buying business people jewelry or furs would rank even lower.) How can we possibly justify higher taxes on the general public or bigger budget deficits to fund such a peculiar entitlement program?
Proponents of a federal subsidy for meals and entertainment also maintain that it is a "jobs issue."15 But from a national perspective,the argument that cutting the government subsidy for meals and entertainment would cost jobs is wholly without merit. Essentially, there are two possible economic results that could occur if the subsidy for meals and entertainment is eliminated. Either: The important point from a national jobs perspective is that it doesn't matter which of these two results occurs. If less money is spent on meals and entertainment, then more money will be spent on other things, creating jobs in other areas.17 Thus, there is no reason to expect any net effect on total American jobs from ending the subsidy for business meals and entertainment.
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