Meals & Entertainment (M&E) Review

1. Meals & Entertainment (M&E) Review

2. M&E ReviewCourse Objectives At the end of this session you will be able to: • Explain the benefits of an M&E Review • Explain the fundamental tax laws relating to M&E expenditures

3. M&E Review • What drives a taxpayer to engage in an M&E Review? • Overview and Evolution of the Law • Sec. 274(D) • Tax Reform Act of 1986 • 1993 • Directors Memo • Rev. Proc. 2004-29

4. Section 274: The 50% Limitation on Deductions and Exceptions to the Limitation • Taxpayers are overlooking exceptions to the standard 50% disallowance (i.e., recreation, de minimis, reimbursed expenses, etc.) and are inadvertently limiting fully deductible expenses (i.e., lodging, airfare, transportation, training fees, etc.) • A Meals & Entertainment (M&E) Review can correct these oversights and result in considerate permanent tax savings (refundable income taxes and interest). • These savings apply to: • Open back tax years • The current tax year • Permanent future benefits in ensuing tax years • Taxpayers may use statistical sampling in M&E Reviews to reduce the labor intensity of effort and the intrusion on taxpayer operations.

5. M&E ReviewExample of Tax and Interest Savings • Estimated Annual M&E Schedule M $5,000,000 • Average Reduction in M&E Disallowance (ranges 20%-30%) 20% • Potential Additional Annual Deduction $1,000,000 • Permanent Tax Savings (Effective Tax Rate @ 40%) $400,000 • Open Tax Years - Including Current Year 5 • Potential Tax Savings $2,000,000 • Estimated Interest Savings (@ 6%) $240,000 • Tax and Interest Savings of M&E Study $2,240,000 1 2 • Experience indicates an M&E Review can often decrease the annual M&E Schedule M between 20% and 30% • Annual Savings Going Forward of $400,000 per year

6. Statistical Sampling: Background • Why use statistical sampling for M&E studies? • Reduces project costs and better controls scope • Reduces burden by limiting record retrieval • Increases budgetary flexibility by linking sample size to potential benefit • Is well accepted in the marketplace • Conforms with IRS expectations

7. Statistical Sampling: Background (continued) • What is the IRS position on the use of statistical sampling for M&E studies? • March 2002 Field Directive provides general statistical sampling guidance • Rev. Proc. 2004-29 provides specific statistical sampling guidance for M&E Reviews • Six IRS regional statistical sampling coordinators provide consistency and coordination that are implemented through about 400 Computer Audit Specialists (“CAS”) • E&Y maintains close, on-going relationships with IRS coordinators

8. Statistical Sampling: Rev. Proc. 2004-29 • Identifies time and cost of analyzing data as criteria for use • Restricts samples to no more than a 3-year period • Allows simple or stratified random sampling • Specifies multiple estimators; select one with smallest standard error • Requires minimum sample size of 100 for certain estimators and at least 30 per stratum • Allows point estimate at 10% or better relative precision • Requires least favorable bound based on a one-sided 95-percent confidence bound if 10% precision goal not met • Requires full documentation • Specifies de minimis fringe frequency & value testing guidance • Required for taxable years ending on or after May 3, 2004

9. Statistical Sampling: Defining the Target Population • The target population can include: • Up to 3 tax years; sometime more with advance IRS agreement • Consolidated group, a single business unit, or multiple business units • Data from multiple M&E accounts, including those that the taxpayer originally classified as 50-percent, 100-percent, and non-deductible • IMPORTANT NOTE: Results can only be projected back to the population from which the sample was drawn

10. Limitations / Exceptions on M&E Deductions • 50% Limitation (IRC § 274(n)) • In general, only 50% of meal and entertainment expenses are allowed as a deduction, unless one of the available exceptions applies. • Exceptions to 50% Limitation (IRC § 274(n)(2)) • Expenses Treated as Compensation (IRC § 274(e)(2)) • Reimbursed Expenses (IRC § 274(e)(3)) • Recreation Exception (IRC § 274(e)(4)) • Items Available to Public (IRC § 274(e)(7)) • Entertainment Sold to Customers (IRC § 274(e)(8)) • Expenses Includible in Income of Persons who are not Employees (IRC § 274(e)(9)) • De minimis fringe benefit (IRC § 132(a)(4)) • Convenience of the Employer (IRC § 119)

11. Reimbursed Expense Exception (IRC § 274(e)(3)) • Exception applies to expenses incurred by the taxpayer on behalf of its clients, if satisfies substantiation requirements. • Exception does not apply to clients that treat client expenses as their own expenses. • Accounting to a client or customer (Reg. § 1.274-5T(h)(3)) • Proper Substantiation Required • The amount of expense • The time and place • The business purpose • The persons entertained and their business relationship to the employee

12. Recreation Exception (IRC § 274(e)(4)) • Primarily for the Benefit of Employees Generally • Partners or shareholders owning less than 10% are considered employees (IRC § 274(e)(4)) • Highly compensated is defined in IRC § 414(q) • Importance of top-paid group election • Meaning of the term “employees generally” • Example of Recreational Activities (IRC § 1.274-2(f)(2)(v)) • Christmas parties, annual picnics, or summer outings • Maintaining a swimming pool, baseball diamond, bowling alley, or golf course • Activities that boost morale

13. De Minimis Fringe Benefits (IRC § 274(n)(2)(B)) • De Minimis Fringe Defined (IRC § 132(e)(1)) • Any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer’s employees) so small as to make accounting for it unreasonable or administratively impracticable. • The Factors • Frequency • Value • Administratively Impracticable

14. Convenience of the Employer (IRC § 119) • Requirements to exclude the value of the meal from the gross income of the employee • For the convenience of the employer • On the business premises of the employer • Interaction of IRC §§ 119, 132 and 274

15. M&E ReviewCommon Types of Engagements • Comprehensive – Review of the open back tax years and the current tax year. There is an opportunity to combine years into a single sample to provide economics of scale for the taxpayer. • Limited - Current year Study and assistance in revising accounting policies and procedures for future M&E tax accounting.

16. M&E ReviewClient Involvement • Flexible • E&Y can turn-key the entire engagement • Taxpayer may drive the effort • E&Y provides the statistical sample and taxpayer participates in the analysis and documentation of the Review. • Statistical sampling reduces intrusion on taxpayer – E&Y can retrieve, analyze and document the Review

17. M&E ReviewWhy Now? • Rev. Proc. 2004-29 validates the use of statistical sampling for M&E Reviews. • Statute of limitations on open years may close • Timing of IRS exam cycles can create urgency • Opportunity for current year, savings in pending returns • Annual recurring tax benefits

18. Questions?