Knowing when and how much meals and entertainment expenses can be deducted is often confusing for business owners.
Generally, business related meals and entertainment expenses for entertaining a client, customer, or employee are deductible in full or in part, if the expense is ordinary and necessary and is either directly related or associated with the conduct of your trade or business. To meet the directly related test you must show that:
- The main purpose of the combined business and entertainment was the active conduct of business
- You did engage in business with the person during the entertainment period, and
- You had more than a general expectation of getting income or some other specific business benefit at some future time.
If your expenses do not rise to the level of directly-related, you may meet the associated test. To meet the test for associated meal and entertainment expenses, you must show that the entertainment is:
- Associated with the active conduct of your trade or business, and
- Directly before or after a substantial business discussion.
Meals and entertainment expenses generally fall into 3 categories: 100% deductible, 50% deductible and nondeductible.
As a rule, most business related meals and entertainment expense are 50% deductible.
The 50% limit applies to business meals or entertainment expenses you have while:
- Traveling away from home (whether eating alone or with others) on business,
- Entertaining customers at your place of business, a restaurant, or other location, or
- Attending a business convention or reception, business meeting, or business luncheon at a club.
In addition to the cost of the meeting or entertainment, related costs are also included in this limitation. Examples of those costs include:
- Taxes and tips relating to a business meal or entertainment activity
- Cover charges for admission to a nightclub
- Rent paid for a room in which you hold a dinner or cocktail party, and
- Amounts paid for parking at a sports arena
It is important to note that the cost of transportation to and from a business meal or a business-related entertainment activity is not subject to the 50% limit.
Let’s discuss the expenses that everyone likes the most – 100% deductible meals and entertainment! Certain meal and entertainment expenses are not subject to the 50% exclusion. Some of the types of expenses that are 100% deductible include:
- Nominal food and beverages. This would include de-minimis food and beverages provided to employees such as food provided at a lunch or breakfast meeting and refreshments to be served to employees or clients at a large group meeting.
- In office business meals where only employees are present. In general, large group meals would qualify and small group meals qualify if they are occasional in nature and are not lavish or extravagant.
- Meals and Entertainment expenses for employee recreation or social purposes such as company picnics and holiday parties.
- Tickets to sporting or cultural events provided to employees on a nondiscriminatory basis. Employers should keep in mind de-minimis rules when determining if this is a taxable fringe benefit to employees.
- Meals for meetings, conferences, seminars or training paid for directly by the company.
- Meals, entertainment, or recreational facilities to the general public as a means of advertising or promoting goodwill in the community. For example, sponsoring a television or radio show or the expense of distributing free food and beverages to the general public is not subject to the 50% limit.
- Expenses reimbursed by a customer or client, or are given an allowance for these expenses in connection with the services you perform.
- Tickets to events that benefit qualified charitable organizations, if the event’s net proceeds go to the charity and the event uses volunteers to perform substantially all the event’s work.
Nondeductible Meals and Entertainment Expenses
Unfortunately there are some types of expenses that are not deductible at all. These types of expenses include:
- Social, entertainment and country club dues and memberships.
- Expenses for spouses. You generally cannot deduct the cost of entertainment for your spouse or for the spouse of a customer. However, you can deduct these costs if you can show you had a clear business purpose, rather than a personal or social purpose, for providing the entertainment.
- Gift or entertainment. Any item that might be categorized as either a gift or entertainment expense generally will be considered entertainment. However, if you give a customer packaged food or beverages that you intend the customer to use at a later date, treat it as a gift.
- Entertainment facilities. Generally, you cannot deduct any expense for the use of an entertainment facility. This includes expenses for depreciation and operating costs such as rent, utilities, maintenance, and protection. An entertainment facility is any property you own, rent, or use for entertainment. Examples include a yacht, hunting lodge, fishing camp, swimming pool, tennis court, bowling alley, car, airplane, apartment, hotel suite, or home in a vacation resort. You can deduct out-of-pocket expenses, such as for food and beverages, catering, gas, and fishing bait that you provided during entertainment at a facility. These are not expenses for the use of an entertainment facility. However, these expenses are subject to the directly-related and associated tests and to the 50% limit, all discussed earlier.
- You cannot deduct more than the face value of a ticket to a sporting or other event. For example, you cannot deduct ticket broker fees or additional premiums paid to scalpers. Also, if you rent a luxury or sky box, your deduction is limited to the cost of a standard, non-luxury ticket. This deduction is still subject to the other meal and entertainment qualifications and limitations.
- You cannot deduct expenses for meal and entertainment expenses that are considered lavish or extravagant. The determination of whether an expense is lavish or extravagant is determined by taking into consideration the facts and circumstances of the expenses incurred.
Whichever category your meal and entertainment expenses fall into, it is important to remember the need to meet the substantiation and recordkeeping requirements. It is also highly recommended to separate your meals and entertainment expenses in separate general ledger accounts depending on the tax treatment of the expenses for ease in identifying the types of expenses during tax preparation.