The requirements for deducting business meals and
entertainment expenses are always a subject that I
am asked about. This type of expense requires you to
jump through several extra hoops to qualify as
deductible and is subject to limitations. Nevertheless,
if you pay careful attention to rules outlined below, the
expenses should qualify as deductible.
(1) Ordinary and necessary business expenses. All
business expenses must meet the general
deductibility requirement of being "ordinary and
necessary" in carrying on the business. These terms
have been fairly broadly defined to mean customary or
usual, and appropriate or helpful. Thus, if it is
reasonable in your business to entertain clients or
other business people you should be able to pass
this general test.
(2) "Directly related" or "associated with." A second
level of tests specially applicable to meals and
entertainment expenses must also be satisfied.
Under them, the business meal or entertainment
must be either "directly related to" or "associated with"
the business.
"Directly related" means involving an "active"
discussion aimed at getting "immediate" revenue.
Thus, a specific, concrete business benefit is
expected to be derived, not just general goodwill from
making a client or associate view you favorably. And
the principal purpose for the event must be business.
Also, you must have engaged actively during the event,
via a meeting, discussion, etc.
The directly related test can also be met if the meal or
entertainment takes place in a clear business setting
directly furthering your business, i.e., where there is
no meaningful personal or social relationship
between you and the others involved. Meetings or
discussions that take place at sporting events, night
clubs, or cocktail parties-essentially social events-
would not meet this test.
If the "directly related" test cannot be met, the expense
may qualify as "associated with" the active conduct of
business if the meal or entertainment event precedes
or follows (i.e., takes place on the same day as) a
substantial and bona fide business discussion.
This test is easier to satisfy.
"Goodwill" type of
entertainment at shows, sporting events, night clubs,
etc. can qualify. The event will be considered
associated with the active conduct of the business if
its purpose is to get new business or encourage the
continuation of a business relationship. For meals,
you (or an employee of yours) must be present. That
is, for example, if you simply cover the cost of a client's
meal after a business meeting but don't join him at it,
the expense does not qualify.
(3) Substantiation. Almost as important as qualifying
for the deduction are the requirements for proving that
it qualifies. The use of reasonable estimates is not
sufficient to stand up to IRS challenge. You must be
able to establish the amount spent, the time and
place, the business purpose, and the business
relationship of the individuals involved. Obviously, you
must set up careful and detailed record-keeping
procedures to keep track of each business meal and
entertainment event and to justify its business
connection. For expenses of $75 or more,
documentary proof (receipt, etc.) is required.
(4) Deduction limitations. Several additional
limitations apply. First expenses that are "lavish or
extravagant" are not deductible. This is generally
a "reasonableness" test and does not impose any
fixed limits on the cost of meals or entertainment
events. Expenses incurred at first class restaurants or
clubs can qualify as deductible.
More importantly, however, once the expenditure
qualifies, it is only 50% deductible. Obviously, this rule
severely reduces the tax benefit of business meals
and entertainment. If you spend about $50 a week on
qualifying business meals, or $2,500 for the year, your
deduction will only be $1,250, for tax savings of
around $300 to $400.
I hope the above has been helpful. Please call if you
have any questions or would like my help in setting up
record-keeping procedures.
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