Business Entertainment Expenses
As a business owner, you are entitled to deduct certain expenses on your tax return such as those relating to entertaining clients. Entertainment is considered any activity that provides entertainment, amusement or recreation. It may also include meeting the personal, living or family needs of individuals including providing meals, a hotel suite or a car to customers or their families.
A meal that you provide to a customer or client may also be considered a form of entertainment. The meal may be part of other entertainment or stand alone. Meal expenses are defined as the cost of food, beverages, taxes and tips for the meal. To deduct an entertainment-related meal, you or your employee must be present when the food or beverages are provided, and you cannot deduct a meal as both a travel and an entertainment expense.
Limits and Restrictions
Generally, only 50 percent of the amount you pay for entertainment expenses is deductible. Entertainment costs, taxes, tips, cover charges, room rentals, maids and waiters are all subject to the 50 percent limit on entertainment deductions.
Entertainment expenses are also subject to certain limits and restrictions such as whether they qualify as “ordinary and necessary” and are not “lavish or extravagant.” They must also be directly related to or associated with your business, and you must keep detailed records substantiating your expenses (more on this below). Furthermore, the person you entertained must be a business associate; that is, someone who could reasonably be expected to be a customer or conduct business with you such as an employee, client or professional advisor.
If it is customary to entertain a business associate with his or her spouse and your spouse also attends, entertainment expenses for both spouses are deductible, thanks to something called the “closely connected rule.” For more information about this topic, please contact our office.
Note: If you are an employee who is reimbursed under an accountable plan, your employer may reimburse you for 100 percent of your entertainment expenses even though only 50 percent of those expenses are deductible.
Location Must be Conducive to Business
Entertainment expenses are only deductible when they take place in a location conducive to business. A nightclub, theater or sports venue is not inherently considered a place conducive to business. However, if a substantial and bona fide business discussion directly precedes or follows entertainment taking place in a location not ordinarily considered conducive to business, the entertainment may be deemed associated with the business and, therefore, deductible. See below for a further discussion of “associated with.” Hunting and fishing trips can qualify as deductible entertainment under this rule as well. However, the IRS only considers an entertainment event to “directly precede or follow” a business discussion if the two take place on the same day.
Your home can be a location conducive to business. For example, if you hold a small (less than 12 people) party for clients and business associates at your home during the summer, it may be deductible as long as you discussed business with your guests. The amount of time spent discussing business during the event is not relevant.
Year-end parties for employees as well as sales seminars and presentations held at your home are generally 100 percent deductible under the employee recreation expense exception, provided costs for food and refreshments are reasonable and not lavish. This exception also applies to summer picnics, company golf or bowling outings and similar events.
Out-of-pocket expenses for food and beverages, catering, gas and fishing bait provided at facilities you own or are a member of such as a yacht, hunting lodge, fishing camp, swimming pool or tennis court are deductible subject to entertainment expense limitation of 50 percent. However, you may not deduct expenses related to the depreciation and upkeep of the facility or for rent and utilities.
Note: Dues paid to country clubs, social or golf and athletic clubs are not deductible.
If you rent a skybox or other private luxury box for more than one event at the same sports venue, you generally cannot deduct more than the price of a nonluxury box seat ticket. You can, however, count each game as one event. Deduction for those seats is then subject to the 50 percent entertainment expense limit. If the cost of food and beverages are on a separate receipt, you are allowed to deduct those expenses (as long as they are reasonable) in addition to the amounts allowable for the skybox, subject, of course, to the requirements and limits that apply.
Expenses Must be “Directly Related” or “Associated With”
Expenses are directly related if you can show that there was more than a general expectation of gaining some business benefit rather than simply goodwill. In addition, you must show that you conducted business during the entertainment and that the active conduct of business was your main purpose.
Even if you cannot show that the entertainment was “directly related” you may still be able to deduct the expenses as long as you can prove the entertainment was “associated with” your business. To meet this test, you must have had a clear business purpose when you took on the expense, and the entertainment must directly precede or come after a substantial business discussion.
Substantiating Your Expenses
The tax law requires you to keep records that will prove the business purpose and amounts of your business entertainment as well as other business expenses. The most frequent reason that the IRS disallows entertainment expenses is the failure to show the place and business purpose of an item. Therefore, it is paramount that you keep excellent records.
To substantiate entertainment expenses, you must show the following:
- The amount of each separate expense.
- The date, time, place and type of entertainment (e.g. dinner).
- The business purpose and nature of any business discussion that took place.
- The business relationship and the name, title and occupation of the person or people you entertained.
Don’t Miss Out
The tax law is complicated, and this article only touches on a few of the deductions for entertainment expenses to which you might be entitled. If you have any questions about entertainment expenses or need assistance setting up a recordkeeping system to document your business-related activities, don’t hesitate to contact us.