When Can You Deduct Meals and Entertainment Expenses?
Let’s face the facts. Most small business owners are downright lousy when it comes to keeping high quality records of their meals and entertainment expenses. The only thing most are sure of is that they would like to deduct every trip to Starbucks, every lunch at Taco Mac, and every dinner they ate on their last vacation. Can they? Maybe. So where is the line when it comes to deducting meals and entertainment expenses?
You may be able to deduct the business related meals and entertainment expenses related to entertaining a client, an employee, or a prospective customer. The IRS has two general rules they lay out for taxpayers to see if your meals and entertainment expenses pass the ‘smell’ test.
- THE DIRECTLY RELATED TEST
- THE ASSOCIATED TEST
As I get into these guidelines, I want you to consider this for a moment. One of the key parts to the smell tests is whether or not this kind of expense is common and accepted in your business or trade. It doesn’t necessarily have to be a required expense, but one that would appear to be normal within the constraints of what you do in a particular industry.
The Directly Related Test
To meet the guidelines of the directly-related test for entertainment expenses (including entertainment-related meals), 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.
The really cool thing about the ‘grayness’ of the definition is that it is NOT necessarily true that you have to discuss more business than you do having entertainment. It just needs to be true that the business isn’t incidental while enjoying the entertainment. Well, how in the world do you figure that one out? The key here is documentation.
A well-documented expense backlog showing your meals and entertainment expenditures can be a lifesaver if you are questioned down the road. Do you have a receipt? Did you list the parties involved that you were doing business with that day? Do you have a time, date, and location? Did you discuss what business was potentially being transacted that day? If you don’t now you did at some point. Write it down. All of these will help your cause down the road.
The Associated Test
You may qualify to deduct entertainment expenses based on the Associated Test if the following conditions are met:
- Entertainment is associated with your trade or business, and
- Entertainment is directly before or after a substantial business discussion.
Generally, an expense can be associated if you can show that it had a clear business purpose for having the expense. This is why documenting the nature of the meeting and what was discussed is so helpful.
Outside of these 2 tests, here are three more general rules you should be aware of as you tabulate your numbers for the current tax year.
- You cannot deduct the cost of your meal as an entertainment expense if you are claiming the meal as a travel expense.
- You cannot deduct expenses that are lavish or extravagant under the circumstances. Extravagant would be something like renting a yacht if you normally use an inner tube.
- You generally can deduct only 50% of your unreimbursed entertainment expenses (see 50% Limit).
I get this question each and every year from prospects and clients during tax time. It’s important that you sit down and really assess this closely because you may have legitimate expenses you could take to lower your tax liability. No TIP for me on this one please (LOL—pun intended!) and make sure you get your documentation in order come tax time!
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