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Tax Strategies & Credits

When Business Meals and Entertainment Are Deductible

by
Sherri Hastings
on
8/22/2017
When Business Meals and Entertainment Are Deductible

There's no question that business is successfully done in all different environments, and that essential and profitable conversations occur in a variety of circumstances, including over meals and while entertaining clients. What is sometimes unclear is whether the owner of a business or their employees are able to deduct the costs of those meals or entertainment as an expense. The answer is normally yes, though to take advantage of the rules and get the deduction to which you're entitled, you may have to meet some exacting requirements.

For those who are concerned about reaching for their wallets when the dinner bill comes, the first thing you need to know is that if you're out of town overnight on business and your meals aren't reimbursed by your company, you are always entitled to deduct 50% of the cost. The answer is not always as clear-cut when the bills are part of entertaining a client. Let's take a look at the rules and how they apply to different situations.

The Requirements and Tests

The Internal Revenue Service has established certain criteria for determining whether a business' meal or entertainment expense is deductible. The first criteria is based on whether the expenses are considered “ordinary and necessary” to carry on business. This is loosely defined as an expense that is helpful to carrying on the business relationship, or that is a common or customary type of event. If an expense falls into the category, the next question that needs to be asked is whether the expense is “directly related” to business or “associated with” business. These terms cover very different types of interactions.

For a meal or entertainment expense to be considered “directly related” to doing business, there must be conversation related directly to doing business during the event, and there must be an anticipation that as a result of the event there will be a specific business benefit such as a sale or continued business relations. These expenses can apply to events that are geared specifically towards this type of interaction: if a conversation happens in passing at a cocktail party, sporting event or similar coincidental meeting, it does not apply and the expense can not be deducted. There is no requirement that the anticipated benefit actually comes to pass.

For a meal or entertainment expense to be considered “associated with” doing business, there is only a requirement that a legitimate business conversation occurred on the same day, either before or after the meal expense. The rules permit more time to go by between an entertainment expense and the business conversation if the entertainment expense (such as a sporting event, a show, or night club outing) can be shown to have been scheduled with the purpose of attracting or encouraging new or continued business. It is also notable that you are able to host these potential or current clients at an entertainment event without being present, but if the expense is for a meal than either the business owner or one of the business' employees must participate in the meal in order for a deduction to be taken.

One important aspect of the “associated with” rules is that there is a requirement that you distinguish between expenses for business guests and expenses for non-business guests. You are permitted to deduct the expenses for business guests, as well as for their spouses, colleagues and associates. Expenses for other guests are not considered deductible, and must be accounted for separately.

When you're planning this type of business expense, it's strongly advised that you give consideration to how reasonable an expense: just because it's for business doesn't mean that you have a completely free hand. Expenses that are considered “lavish” may not be considered reasonable, and therefore amounts over a reasonable limit may be denied as an expense. It is also important to remember that either the business owner that is paying the taxes or one of their employees, representatives, or independent contractors that provide work for them must be present at these types of events, whether a meal or at an entertainment venue.

Meeting Accounting Requirements

In addition to understanding the rules for deducting meal and entertainment expenses, you also must meet the IRS' extensive accounting requirements for deductions. The agency needs proof positive of how much you've spent, where and when the expense took place, what the business relationship was between you and those entertained or fed, and more. Keeping a diary of this type of expense, in addition to receipts for those in excess of $75, can go a long way towards proving the validity of an expense.

In weighing whether or not to incur a meal or entertainment expense for your business, it is also important to keep in mind that no more than half of the expenses that are approved can actually be written off. You need to weigh whether the benefit that you are hoping for is worth the expense.

Tim Murphy, CPA writes for TaxBuzz, a tax news and advice website. Reach his office at [email protected].

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Sherri Hastings

Sherri Hastings

Tim Murphy is the managing member at Murphy & Murphy, CPA, LLC, a full-service certified public accounting firm, with emphasis on tax preparation, audits of governmental, educational, and non-profit entities, retirement planning, estate planning, business valuations, litigation support, and banking. He is a Certified Public Accountant in Maryland and Virginia. Tim is also a CERTIFIED FINANCIAL PLANNER professional, Personal Financial Specialist, Accredited Estate Planner, Certified Valuation Analyst, and Investment Adviser Representative.

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