By Chris Peden
According to IRS Publication 463, Travel Entertainment, Gift and Car Expenses, you can deduct the costs of meals and entertainment when they “are both ordinary and necessary and meet one of the following tests:
So what does all that mean? “Ordinary” means that it would be the type of expense that a normal person would expect someone in your line of business to purchase. For instance, you would expect a salesman to take a client to a four-star restaurant, but not a math tutor. “Necessary” means that it is an expense that would be appropriate for the type of business you are in, and would be helpful to having the business operate the way it should. In order for the expenses to be directly related, its purpose must be for the active conduct of the business, must have incurred while doing some business with whom you entertained, and you expected to gain the prospects business from the event.
To meet the associated test, you have to be able to prove that the expense was for the active conduct of your business, and business discussions or activity occurred before or after the activity. You will want to keep a log listing who you met with and the purpose of the event.
Now that you know how to tell if something is deductible, it’s time for a little bad news: You can only deduct 50% of what you spend on business meals and entertainment. This limit applies to expenses you incur when you are traveling away from home, entertaining customers at a restaurant, your office, or another location, or while you are attending a convention, reception, business meeting or a meal at a club. The items that would be subject to this 50% limit would be charges for taxes and tips, while you are attending a convention, reception, business meeting or a meal at a club.
However, there are some expenses that are not subject to this 50% limit. The cost of travel to and from business related meals or entertainment are not subject to the 50% limit. In addition, if you are a business owner and self-employed, your expenses would not be subject to the limit if (1) You incur these expenses as an independent contractor, (2) your client reimburses you in some manner for these expenses, either directly or through an allowance, and (3) you provide a record of expenses to your client.
So what types of expenses are deductible? You can deduct expenses for an activity that would provide entertainment, amusement, or recreation, as well as cost of meals that you provide to a customer, whether or not they are part of the entertainment, or expenses directly related to the attendance at business meetings, conventions, or trade association meetings.
There are some expenses that are not deductible. Amounts spent for club dues and membership fees, the use of entertainment facility, and spouses are not deductible. If you have an item that could be considered either a gift or entertainment, such as tickets to a baseball game, it is up to you to determine whether it is a gift or entertainment. You would want to choose the one with the greatest tax advantage. Consult an accountant if you have any questions.
Chris Peden, CPA, CMA, CFM has over 15 years in the corporate world helping companies meet their regulatory compliance requirements. He also assists individuals with their taxes, and helps small business owners with organizing and making sense of their finance information.