Many new business owners are surprised to learn that it’s perfectly legitimate to deduct the business expenses associated with meals, events, and other entertainment costs on their income tax returns. The fact is that the IRS considers feeding and entertaining clients, business associates, and employees to be a necessary part of running a business – so long as these expenses meet the necessary criteria.
Do My Expenses Qualify as Deductions?
Figuring out for sure whether your company’s expenses qualify as deductions can be a little tricky at times, but the “litmus test” for allowable deductions begins with understanding the government’s definition of a legitimate entertainment expense. In order for your expenses to be considered deductible, they have to be:
- ordinary and necessary business expenses
- directly related to your business, or intimately associated with it
When an expense is ordinary and necessary, it means that it’s “common and accepted in your trade or business”. But by “necessary”, the government doesn’t automatically expect the expense to be one that’s indispensable, as long as it’s both helpful and appropriate for the business you’re in.
When it comes to making sure your entertainment costs qualify as either directly or closely associated with your business, things start to get slightly more complicated. When costs are direct, it means that a meal or entertainment event was either held at a business venue like your office, or that there was at least a specific and undisputable professional reason for the event – meaning that business was discussed for the purpose of increasing income or improving some other area of your business operations. Associated expenses are those that are not only linked to your business, but that immediately precede or follow a substantial business discussion.
All of this may sound a little vague and confusing to the uninitiated, so it’s always a good idea to seek professional help whenever you’re trying to differentiate between allowable entertainment expenses and those that don’t qualify as deductible.
How Much Can I Deduct?
In the vast majority of cases, both meal and entertainment costs are only deductible at 50%. This means you’ll only be able to claim half the costs of that office party you’ve been planning so enthusiastically. But there are usually exceptions to every rule, and the 50% deduction limit is no different. Some of the more common exceptions you should be aware of include:
- transportation costs to and from a business meal or business-related entertainment activity
- meals or entertainment that are provided to the general public to promote or advertise your business
- certain self-employment situations
In these cases, you can potentially deduct 100% of your entertainment-related expenses, but you need to recognize that meals can’t be claimed as both entertainment expenses and travel expenses, and promotional costs like those described above should be categorized as advertising rather than entertainment.
If you’re an independent contractor or otherwise self-employed, the IRS says your entertainment expenses have to meet certain conditions in order to be deducted at 100%. If they qualify, then your client or customer will be the one subjected to the 50% deduction limit:
- you have to be an independent contractor
- your customer has to reimburse you or give you an allowance for the relevant expenses
- you have to provide your customer with proper documentation of the expenses
Keeping Proper Records
On the topic of proper documentation, it’s vital for your business to keep accurate records of any entertainment expenses it plans to claim. These records not only have to indicate the date, place, amount, and type of expense – like a detailed restaurant meal receipt would, for example – they also have to show how the expense qualifies as one that’s either direct or associated where your business is concerned.
What the IRS is really saying in terms of recording entertainment expenses is that this documentation should prove that the cost had a legitimate underlying business purpose; so it’s important to outline the business relationship of the person or people being entertained. A qualified accountant or bookkeeper can help you with your record keeping.
Beware the Non-Deductible Expense
Some entertainment expenses simply don’t qualify as deductions at all. Lavish events that go beyond what’s considered “appropriate”, membership fees and dues for most entertainment organizations (think golf and country clubs), and any expense related to the use of an “entertainment facility” owned or rented by your business – including things like yachts, vacation properties, cars, and swimming pools - are all examples of expenses that rarely fall under the heading of deductible.
Overall, you should always be prepared for the IRS to perk up its ears and initiate an audit any time your business claims entertainment costs that could easily be construed as personal expenses. Make sure your business can produce suitable proof in the form of consistent, accurate accounting records and other documentation, in order to avoid having these expenses disallowed and removed from your company’s income tax return.
