The most widely abused deductions for businesses are expenses related to meals and entertainment. The IRS tries to limit the abuse of these deductions by imposing strict regulations on these types of deductions. It is important for all business owners to understand the tax rules for taking meals and entertainment deductions since these expenses are typically scrutinized by the IRS.
Most typical business expenses are allowed a full 100% deduction while the IRS only allows businesses to deduct 50% of qualifying meals and entertainment expenses. The IRS also draws a line as to which types of expenses will qualify for the 50% deduction and which ones they will not allow any deduction.
What Is Business Entertainment? What is a Business Meal?
Meal and entertainment expenses can only be deducted if it is determined that they are ordinary and necessary. To be considered ordinary and necessary it must meet the requirements for one of the follow two tests:
- Directly Related: The sole purpose of the entertainment related activity that is being expensed is the conduct of business. This means that the purpose of the entertainment must have some type of business purpose. This event could have been to gain income or in some way benefit the business in the future.
- Associated: The entertainment this is being deducted was associated with the active conduct of business. This means that the entertainment expense could be directly before or after a business discussion.
Both of these tests do come with their limitations. Below we will go more into detail on the limitations of these types of deductions.
Who Can You Entertain?
In order to qualify the expense as a deduction you must have at least one person present that is there with the intent to benefit your business in some way. Below is a short list of people that typically qualify as people you can entertain.
There is no set list of titles that the IRS puts out as qualifying people. Pretty much anyone can qualify as long as there was a business purpose for them being included in the entertainment. If there were a combination of business related people and non business related people at the entertainment event then it is likely that all of the expenses will not be allowed.
What Can & Can’t Be Deducted?
There is no standard list as to what can be deducted and what can’t, it is dependent upon the situation. It is important to be able to tell the difference between a regular business activity (100% deduction), business entertainment (50% deduction), and general entertainment (0% deduction). Since the list of deductions can go on forever, below are a few examples of each situation.
- General Business Expense (100% deduction)
- Paying for meal for an employee that is working overtime: Since this does not provide any type of entertainment and is for strict business purpose, this qualifies as a general business expense.
- Motel room during business travel: The purpose of the trip is for business and this would be considered a travel expense, which is a 100% deduction.
- Provide food for potential clients to market your deli: Since the food offered is available to the general public and is used for marketing purposes, this expense is considered a marketing expense.
- Business Entertainment (50% deduction)
- Meal at nice restaurant with potential buyer: If the main purpose of meal was to discuss a potential business deal and you picked up the entire tab, then 50% of this can be used as a tax deduction.
- Football game after business negotiations: If the entertainment followed a business activity, it can likely be considered a business entertainment expense.
- General Entertainment (0% deduction)
- Fishing trip that business was discussed during the fishing trip: As a general rule, you cannot deduct most entertainment if you claimed you discussed business during the activity, only if it is a meal. The IRS believes it is not possible to conduct business in a serious matter during most types of entertainment. If you claim that business discussions happened before or after the fishing trip, that is another story.
- Dinner with old business partner with very brief business discussions: If the purpose of the meeting was not for the purpose of business, no deduction is allowed. Just having a brief discussion with nothing substantial discussed, does not qualify this type of entertainment.
If you are like most businesses, entertainment is an important business activity that is used to grow your business. Understanding what is allowed as an expense can help you save some serious money in taxes by taking the proper deductions.