A professional practice isn’t conducted solely in an office. Your most important business meetings, client contacts, and marketing efforts can take place at restaurants, golf courses, or sporting events. The tax law recognizes this and permits you to deduct part of the cost of business related entertainment. However, taxpayers have abused this deduction in the past, so the IRS has imposed strict rules limiting the types of entertainment expenses you can deduct and the amount of the deduction you can take. This post emphasize on this topic through the following sections: what is business entertainment?, activities that aren’t entertainment, meals can be travel or entertainment, who you can entertain, deducting entertainment expenses, business discussions before or after entertainment, business discussions during meals, entertaining at home, entertainment in clear business settings, calculating your deduction, expenses must be reasonable, expenses you can’t deduct, entertainment tickets, and meals for employees.
What Is Business Entertainment?
You may deduct only half of the total amount you spend on business entertainment activities. Because ordinary and necessary business activities are usually fully deductible, you want to be able to distinguish between regular business activities and entertainment. The basic rule is that entertainment involves something fun, such as: dining out, going to a nightclub, attending a sporting event, going to a concert, movie, or the theater, visiting a vacation spot (a ski area or beach resort, for example), or taking a hunting, yachting, or fishing trip.
Although eating out might fall into other categories of business operating expenses depending on the circumstances, it is by far the number one business entertainment expense.
Activities That Aren’t Entertainment
Entertainment does not include activities that are for business purposes only and don’t involve any fun or amusement, such as: providing supper money to an employee working overtime, paying for a hotel room used while traveling on business, or transportation expenses incurred while traveling on business.
In addition, meals or other entertainment expenses related to advertising or promotions are not considered entertainment. As a rule, an expense for a meal or other entertainment item will qualify as advertising if you make it available to the general public—for example, if a dentist provides free coffee and soft drinks to patients in his waiting room, the cost would not be considered an entertainment expense. These kinds of advertising and promotion costs are fully deductible business operating expenses.
Meals Can Be Travel or Entertainment
A meal can be a travel expense or an entertainment expense, or both. The distinction won’t affect how much you can deduct—both travel (overnight) and entertainment expenses are only 50% deductible. But different rules apply to the two categories. A meal is a travel expense if you eat out of necessity while away from your tax home on a business trip. For example, any meal you eat alone while on the road for business is a travel expense. On the other hand, a meal is an entertainment expense if you treat a client, customer, or other business associate, and the purpose of the meal is to benefit your practice. A meal is both a travel and an entertainment expense if you treat a client or other business associate to a meal while on the road. However, you may deduct this cost only once—whether you choose to do it as an entertainment or a travel expense, only 50% of the cost is deductible.
Who You Can Entertain
You must be with one or more people who can benefit your business in some way to claim an entertainment expense. This could include current or potential: clients, customers, suppliers, employees, independent contractors, agents, partners, or professional advisors. This list includes almost anyone you’re likely to meet for business reasons. Although you can invite family members or friends along, you can’t deduct the costs of entertaining them, except in certain limited situations.
Deducting Entertainment Expenses
Entertainment expenses, like all business operating expenses, are deductible only if they are ordinary and necessary. This means that the entertainment expense must be common, helpful, and appropriate for your practice. Taxpayers used to have to show only that the entertainment wasn’t purely for fun, and that it benefited their business in some way. This standard was so easy to satisfy that the IRS imposed additional requirements for deducting these expenses.
Before the IRS made the standard tougher, you could deduct ordinary and necessary entertainment expenses even if business was never discussed. For example, you could deduct the cost of taking a client to a restaurant, even if you spent the whole time drinking martinis and talking about sports [the infamous three-martini lunch]. This is no longer the case—now you must discuss business with one or more business associates either before, during, or after the entertainment if you want to claim an entertainment deduction (subject to one exception: see “Entertainment in Clear Business Settings,” below).
Who’s going to know? The IRS doesn’t have spies lurking about in restaurants, theaters, or other places of entertainment, so it has no way of knowing whether you really discuss business with a client or other business associate. You’re pretty much on the honor system here. However, be aware that if you’re audited, the IRS closely scrutinizes this deduction because many taxpayers cheat when they take it. You’ll also have to comply with stringent record-keeping requirements.
Business Discussions Before or After Entertainment
The easiest way to get a deduction for entertainment is to discuss business before or after the activity. To meet this requirement, the discussion must be “associated” with your practice—that is, it must have a clear business purpose, such as developing new business or encouraging existing client relationships. You don’t, however, have to expect to get a specific business benefit from the discussion. Your business discussion can involve planning, advice, or simply exchanging useful information with a business associate. You automatically satisfy the business discussion requirement if you attend a business-related convention or meeting to further your business.
Business activities—not socializing—must be the main purpose for the convention. Save a copy of the program or agenda to prove this. Generally, the entertainment should occur on the same day as the business discussion. However, if your business guests are from out of town, the entertainment can occur the day before or the day after the business talk.
You can get a deduction even if the entertainment occurs in a place like a nightclub, theater, or loud sports arena where it’s difficult or impossible to talk business. This is because your business discussions occur before or after the entertainment, so the IRS won’t be scrutinizing whether or not you actually could have talked business during your entertainment activity.
Business Discussions During Meals
Another way you can deduct entertainment expenses is to discuss business during a meal at a restaurant. To get the deduction, you must show that:
- the main purpose of the combined business discussion and meal was the active conduct of business—you don’t have to spend the entire time talking business, but the main character of the meal must be business
- you did in fact have a business meeting, negotiation, discussion, or other bona fide business transaction with your guest or guests during the meal; and
- you expect to get income or some other specific business benefit in the future from your discussions during the meal—thus, for example, a casual conversation where the subject of business comes up won’t do; you have to have a specific business goal in mind.
You don’t necessarily have to close a deal, sign a contract, or otherwise obtain a specific business benefit to get a deduction. But you do have to have a reasonable expectation that you can get some specific business benefit through your discussions at the meal—for example, obtaining a new client or investment in your practice.
No Deductions for Business Discussions During Other Kinds of Entertainment
As a general rule, you can’t get a business entertainment deduction by claiming that you discussed business during an entertainment activity other than a meal. In the IRS’s view, it’s usually not possible to engage in serious business discussions at entertainment venues other than restaurants because of the distractions. Examples of places the IRS would probably find not conducive to serious talk include:
- nightclubs, theaters, or sporting events
- cocktail parties or other large social gatherings
- hunting or fishing trips
- yachting or other pleasure boat outings, or
- group gatherings at a cocktail lounge, golf club, athletic club, or vacation resort that includes people who are not business associates.
This means, for example, that you usually can’t claim that you discussed business during a golf game, even if your foursome consists of you and three business associates. In the IRS’s view, golfers are unable to play and talk business at the same time. On the other hand, you could have a business discussion before or after a golf game—for example, in the clubhouse. This might seem ridiculous, but it is the rule.
Entertaining at Home
The cost of entertaining at your home is deductible if it meets either of the above two tests. However, the IRS will be more likely to believe that you discussed business during home entertainment if only a small number of people are involved—for example, if you have a quiet dinner party. A larger gathering—a cocktail party, for example—will probably qualify as an entertainment expense only if you have business discussions before or after the event. (For example, you sign a contract with a client during the afternoon and invite him to your house for a large party with your business associates and family.) You can’t, however, deduct the costs of inviting nonbusiness guests to your house.
Entertainment in Clear Business Settings
An exception to the general rule that you must discuss business before, during, or after entertainment is when the entertainment occurs in a clear business setting. For example, this exception applies to:
- the price of renting a hospitality room at a convention where you discuss your services or products; or
- entertainment that occurs under circumstances where there is no meaningful personal relationship between you and the people you entertained—for example, you entertain local business or civic leaders at the opening of a new hotel to get publicity for your practice, rather than to form business relationships with them.
Calculating Your Deduction
Most expenses you incur for business entertainment are deductible, including meals [with beverages, tax, and tips], your transportation expenses [including parking], tickets to entertainment or sporting events, catering costs of parties, cover charges for admission to nightclubs, and rent paid for a room where you hold a dinner or cocktail party.
You are allowed to deduct only 50% of your entertainment expenses, including taxes and tips. For example, if you spend $50 for a meal in a restaurant, you can deduct $25. You must, however, keep track of everything you spend and report the entire amount on your tax return.
The only exceptions to the 50% rule are transportation expenses, which are 100% deductible, and certain meals for employees. If you have a single bill or receipt that includes some business entertainment as well as other expenses (such as lodging or transportation), you must allocate the expense between the cost of the entertainment and the cost of the other services. For example, if your hotel bill covers meals as well as lodging, you’ll have to make a reasonable estimate of the portion that covers meals. It’s best to try and avoid this hassle by getting a separate bill for your deductible entertainment.
Expenses Must Be Reasonable
Your entertainment expenses must be reasonable—the IRS won’t let you deduct entertainment expenses that it considers lavish or extravagant. There is no dollar limit on what is reasonable; nor are you barred from entertaining at deluxe restaurants, hotels, nightclubs, or resorts.
Whether your expenses will be considered reasonable depends on the particular facts and circumstances—for example, a $250 expense for dinner with a client and two business associates at a fancy restaurant would probably be considered reasonable if you closed a business deal during the meal. Because there are no concrete guidelines, you have to use common sense.
Expenses You Can’t Deduct
There are certain expenses that you are prohibited from deducting as entertainment.
- Entertainment Facilities – An entertainment facility is any property you own, rent, or use for entertainment—for example, a yacht, hunting lodge, fishing camp, swimming pool, car, airplane, apartment, hotel suite, or home in a vacation resort. You may not deduct any expense for the use of an entertainment facility, including expenses for depreciation and operating costs such as rent, utilities, maintenance, or security. However, you can deduct out-of-pocket expenses that you incur while providing entertainment at an entertainment facility—for example, costs for food and beverages, catering, gas, and fishing bait. These are not expenses for the use of an entertainment facility itself.
- Non-business Guests’ Expenses – You may not deduct the cost of entertaining people who are not business associates. If you entertain business and non-business guests at an event, you must divide your entertainment expenses between the two and deduct only the business part. Ordinarily, you cannot deduct the cost of entertaining your spouse or the spouse of a business associate. However, there is an exception: You can deduct these costs if you can show that you had a clear business purpose (rather than a personal or social purpose) in having the spouse or spouses join in.
- Club Dues and Membership Fees – In the good old days, you could deduct dues for belonging to a country club or other club where business associates gathered. This is no longer possible. The IRS says you cannot deduct dues (including initiation fees) for membership in any club if one of the principal purposes of the club is to conduct entertainment activities for members, OR provide entertainment facilities for members to use.
Thus, you cannot deduct dues paid to country clubs, golf and athletic clubs, airline clubs, hotel clubs, or clubs operated to provide members with meals. However, you can deduct other expenses you incur to entertain a business associate at a club.
You can deduct dues to join business-related tax-exempt organizations or civic organizations as long as the organization’s primary purpose isn’t to provide entertainment. Examples include professional associations such as a medical or bar association, as well as organizations like the Kiwanis or Rotary Club, business leagues, chambers of commerce, and trade associations.
You can deduct only the face value of an entertainment ticket, even if you paid a higher price for it. For example, you cannot deduct service fees that you pay to ticket agencies or brokers, or any amount over the face value of tickets that you buy from scalpers. However, you can deduct the entire amount you pay for a ticket if it’s for an amateur sporting event run by volunteers to benefit a charity.
Ordinarily, you or an employee must be present at an entertainment activity to claim it as a business entertainment expense. This is not the case, however, with entertainment tickets. You can give tickets to clients or other business associates rather than attending the event yourself, and still get a deduction. If you don’t go to the event, you have the option of treating the tickets as a gift. You can get a bigger deduction this way sometimes. Gifts of up to $25 are 100% deductible, so with tickets that cost less than $50, you get a bigger deduction if you treat them as a gift. If they cost more, treat them as an entertainment expense.
You may also deduct the cost of season tickets at a sports arena or theater. But, if you rent a skybox or other private luxury box, your deduction is limited to the cost of a regular non-luxury box seat. The cost of season tickets must be allocated to each separate event.
Meals for Employees
Ordinarily, meal and entertainment expenses for your employees are only 50% deductible, just like your own meal and entertainment expenses. However, you or your practice may take a 100% deduction for employee meals:
- provided as part of a company recreational or social activity—for example, a picnic for your employees
- provided on business premises for your convenience—for example, you provide lunch because your employees must remain in the office to be available to work, or
- if the cost is included as part of the employee’s compensation.
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