Business Meals and Entertainment are part of every small business. If you incur business meals and entertainment keep in mind that you’ll need to follow these rules to support the deduction and even then the business meals and entertainment expenses will be limited:
Ordinary and necessary – All business expenses must meet the general deductibility requirement of being “ordinary and necessary” in carrying on the business. Another way to look at it is to ask if the expenses are customary or usual, and appropriate or helpful to the conduct of your business. Thus, if it is reasonable in your business to entertain clients or other business people you should be able to pass this general test.
“Directly related” or “associated with” – In addition to being ordinary and necessary, meals and entertainment expenses must be either “directly related to” or “associated with” the business.
To be directly related, the expense needs to involve an active discussion aimed at getting immediate revenue. These expenses need to have an objective of getting additional business and not just general goodwill. It also requires that you discuss business actively during the event. If the expense takes place in a clear business setting, it is easy to meet the directly related test. But when the discussion takes place at a sporting event, night club or party, it doesn’t meet this test. However the expense may qualify as “associated with” the active conduct of business if the meal or entertainment event precedes or follows (i.e., takes place on the same day as) a substantial and bona fide business discussion. Under these circumstances, the event will be considered associated with the active conduct of the business if its purpose is to get new business or encourage the continuation of a business relationship. For meals, you (or an employee of yours) must be present for the expense to qualify.
Substantiation. There’s an old saying in the accounting field that “if it wasn’t documented, it didn’t happen.” Almost as important as qualifying for the deduction are the requirements for proving that it qualifies. Using a reasonable estimate isn’t sufficient to stand up to the IRS. To substantiate the expenses, keep documentation that establishes the amount spent, the time and place, the business purpose, and the business relationship of the individuals involved. For expenses of $75 or more, you will also need a copy of the receipt to go along with the documentation. There are several apps that make it easy to meet these requirements from the convenience of your smart phone.
Deduction limitations. Now you have jumped through the first three hurdles just to learn that additional limitations may apply. First, expenses that are “lavish or extravagant” aren’t deductible. There’s no hard and fast rule about what is lavish or extravagant, but most of us have enough common sense to understand what would raise additional scrutiny. More importantly, however, once the expenditure qualifies, it is only 50% deductible, reducing the tax benefit.
When it comes to business meals and entertainment here’s a quick list to keep in mind:
Is it an ordinary and necessary part of our business?
Is it directly related or associate with the prospect of obtaining immediate new business?
Did I document amount spent, the time and place, the business purpose, and the business relationship of the individuals involved?
If the expense was over $75, did I keep the receipt?
Could the expenditure be considered as lavish or extravagant?
Answer these questions and document your business meals and entertainment to support the deductions. As always, consult a qualified tax professional with any questions you have regarding your business.