Business Meals and Entertainment Expenses:
What You Can and Cannot Deduct

Taking current and prospective clients or customers out to dinner, theater, or a sports game makes good business sense and, as an added bonus, provides you with valuable tax deductions. However, the rules for deductibility of business meals and entertainment are often confusing and complex. In this article I hope to clarify some common misconceptions and help you maximize your deductions.

2-PRONGED TEST

Business meals or entertainment expenses must pass two tests in order to qualify for deduction. In the first test, meals and entertainment expenses must be “ordinary and necessary.” An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate, although not necessarily required for your business.

A salesperson who takes a customer to lunch in order to discuss a purchase order meets the test of “ordinary and necessary” expense and can deduct the cost of the meal because it is customary. A doctor who takes a patient out to dinner would not meet this test because it is not customary for doctors to take their patients out for dinner.

To pass the second test the expense must be either “directly related” or “associated with” the business activity. To meet the directly related test you must be able to show that the main purpose of the expense was to engage in the active conduct of a business with the person being entertained. Taking a client to a concert would likely fail the directly related test because it is difficult to actively conduct business at a concert.

Meals and entertainment expenses are “associated with” business if they have a clear business purpose and the meal or entertainment directly precedes or follows a substantial business discussion. The example above of taking a client to a concert would fail the directly related test, but it could pass the “associated with” test if business discussions took place before or after the concert.

50-PERCENT VS. 100-PERCENT DEDUCTION FOR MEALS AND ENTERTAINMENT EXPENSE

Generally, expenses related to entertainment of clients or customers are subject to a 50% limitation. This means that if you spend $100, only $50 is deductible for tax purposes. The 50% limitation also applies when attending business conventions, meetings or luncheons.

However, there are certain expenses that are 100% deductible for tax purposes. The following are a few examples:

1) Meals provided to employees related to social or recreational activities provided that all employees are invited. Examples include company Christmas parties or retirement parties.

2) Meals provided for the convenience of the employer. These could include meals provided due to short lunch periods or lack of a nearby eatery. If a meal is provided to more than half of the employees for the employer’s convenience, then the employer can deduct 100% of the meals.

3) De minimis fringe benefit meals also qualify for 100% deduction. This includes meals that are provided infrequently or cost so little that it is not worth the time spent to fully account for them. To fully capture 100% deductible expenses it is recommended that you record these expenses in an account separate from expenses related to entertainment of clients. Please see the table below for more detailed examples of percentage of deduction.

SEASON OR LUXURY SUITE TICKETS

If you buy season or series tickets for business use, each ticket must be treated as a separate item. To determine the cost of individual tickets, divide the total cost by the number of games in the series. You can use this cost per ticket as long as it does not exceed the ticket’s face value. You must keep records in order to show whether you used the tickets as a gift or entertainment.

If you rent a skybox or private luxury suite for more than one event at the same sports arena, you cannot deduct more than the price of a non-luxury box seat ticket. Renting a skybox for a series of playoff games is considered renting it for more than one event. For example, you pay $4,000 to rent a 10-seat luxury suite for 5 baseball games. The cost of a regular nonluxury box seat at each event is $30 a seat. You can deduct, subject to the 50% limitation, $750 ((10 seats x $30) x 5 games x 50%) not the $4,000 you paid.

Please note, only the face value of the ticket is deductible even if you paid a higher price to a scalper or a ticket broker.

If you do not attend an entertainment event yourself, you can choose whether to treat the tickets as a business gift, full cost deductible up to $25, or as entertainment in which case 50% is deductible.

GOOD RECORDS ARE CRITICAL

Documentation is key. The IRS often requests meals and entertainment documentation as part of an audit. In addition to producing a receipt for any expense of $75 or more, you must also show the date, place, amount, business purpose of the expense, and the business relationship of the person you entertained. It is a good business policy to make these elements part of any employee expense report. It is important to keep in mind that meal and entertainment expenses attract the attention of the IRS. However, if you meet the requirements for deductibility, and keep accurate and complete records, your deduction should withstand IRS scrutiny.

Please call us if you would like to discuss this topic further. Liting Mitchell, CPA, MPAcc(tax) Tax Department