When are entertainment expenses of a business deductible on a tax return? And which expenses are really entertainment for tax purposes in the first place?
A business can deduct 50% of its expenses to entertain clients, customers, or employees if those expenses are ordinary and necessary and they meet certain requirements. Ordinary means the expense is common and accepted in your trade or business. Necessary means the expenses are supportive and fitting for your business. Entertainment expenses can include activities that provide amusement and recreation or meals.
To deduct entertainment expenses, you must meet the requirements of one of the following two tests:
- “Directly-related” test: To meet the requirements of the directly-related test, you must demonstrate that the main purpose of the entertainment was the active conduct of business, you engaged in business with the person during the entertainment period, and you expected some specific business benefit (not just the general expectation of getting income). If the entertainment took place in a clear business setting and was for your business, the expenses will be considered directly related to your business.
- “Associated” Test: To pass the associated test, your entertainment must be associated with the active conduct of your trade or business and occur directly before or after a substantial business discussion. Generally, an expenditure is associated with the active conduct of your business if you can establish that you had a clear business purpose for having the expense.
There are other rules that limit the 50% deduction for meal and entertainment expenses. For example, you cannot deduct the cost of your meal as an entertainment expense if you are already deducting it as a travel expense. You cannot deduct expenses that are lavish or extravagant under the circumstances. (Although expenses are not disallowed just because they occur at deluxe restaurants, hotels, nightclubs and resorts.) In general, club dues and memberships in recreational organizations are not deductible. There are various other nondeductible or partially restricted entertainment expenses as well; please refer to IRS Publication 463 for these and for other more specific information.
Meal and entertainment expenses are a common deduction for businesses; just make sure you are substantiating your expenses by keeping receipts and documenting the purpose of the business meeting as well as the business relationship of the persons entertained. “What, where, when, with whom and why” are the questions you should be able to answer with your supporting documents.
For questions about a specific entertainment expense, please call our office. We may be able to help you avoid missed opportunities. (For example, golf fees, which are normally 50% allowable when qualified as business expenses, can be 100% deductible if the fees are for a charity tournament that is run substantially by volunteers. This is just one example.) You can also refer to IRS Publication 463, Chapter 2 “Entertainment” for more information.