Business Entertainment: What Can You Deduct?
NEW YORK – Taking a client out for lunch is one of the most basic business activities there is. And it’s one that can run a small business owner afoul of the IRS.
There has been a tug of war for years between the government and businesses over entertainment expenses. The agency is on the lookout for companies that take excessive deductions, or that try to bundle together personal and business expenses.
Barbara Weltman, a tax attorney in Millwood, N.Y., and author of “J.K. Lasser’s Small Business Taxes,” said this has been one of the most litigated areas in tax law.
What follows is a basic look at the deduction for entertainment expenses. Anyone who wants to claim the deduction should read IRS Publication 463, Travel, Entertainment, Gift and Car Expenses. And it’s a good idea to go over these expenses with a tax professional.
Most commonly, people think of business lunches or dinners, or taking clients to the theater, a sporting event or a nightclub. Anyone who has a business and plays golf is also likely to take a client out for a round at a country club. Renting a room and holding a party can constitute a business expense.
But the IRS has rules that can limit the deductions a business owner can take for most forms of entertainment. For example, you can probably deduct the costs of playing golf with your client. But you can’t deduct your membership fees at the club.
Reading the rules before you even spend the money on tickets or a meal is a good idea, especially if the event or food is expensive.
THE 50 PERCENT RULE
A business owner who spends $5,000 a year on business meals and theater or sports tickets isn’t going to get a windfall at tax time.
Weltman said one of the biggest mistakes that owners make with the entertainment deduction is that they don’t realize they can only claim 50 percent of their expenses. So that $5,000 becomes $2,500 on a tax return, and the tax savings is considerably less.
If your entertainment seems to be too lavish for your circumstances, the IRS might put a limit on how much you can claim. It might question your deductions as agency employees review your return, or it might challenge your expenses during an audit. And you’re still subject to the 50 percent rule on the amount the government allows.
There’s an old joke about two business people who want to deduct the cost of their dinner out.
“How’s business?” one asks.
“Don’t ask,” is the reply.
So, they move on to talk about anything and everything else, confident that they’ve satisfied the requirements for a tax deduction.
The IRS doesn’t think it’s funny. Although many small business owners, as a matter of course, deduct the cost of any meal with a business associate, the government’s rules require that the main purpose of a meal or other form of entertainment be “the active conduct of business.”
Moreover, it says in Publication 463, an owner must have “more than a general expectation of getting income or some other specific business benefit at some future time.”
But the IRS does allow the cost of the meal to be deducted if it takes place directly before or after a business discussion. For example, you meet a client in your office and discuss a new contract. When you take the client out for lunch afterward, the meal should qualify for a deduction.
It may turn out that despite your best efforts, you couldn’t cut a deal as a result of the meal. You can still deduct it.
Tax professionals warn about entertainment, and meals in particular, that owners should keep careful records, and not just credit card receipts. Weltman suggests a diary that includes “who you met, what was the purpose, what was the date.”
TICKETS TO EVENTS
Deducting the cost of tickets to events can be a little tricky. A careful reading of Publication 463 is suggested.
For example, if you get the tickets through a ticket broker, you can only deduct 50 percent of the face value of the tickets.
But if you buy tickets to a sporting event that benefits a charitable organization, such as a golf tournament, you can deduct the full amount of the tickets.
If you decide to just give the tickets to your client rather than go yourself, the IRS gives you a choice to treat it as entertainment or as a gift, “whichever is to your advantage.”
In this case, do the math. Under the tax law, businesses are limited to deducting $25 per gift per person in a tax year. So if you gave a client a $100 ticket as a gift, you can deduct only $25. If you treat it as entertainment, you could deduct $50, or 50 percent of the ticket price.
Keep in mind, if the tickets are to be considered an entertainment expense, you’ll have to engage in a business discussion with your client or customer before or after the event. And, if you decide to go, then you must treat it as entertainment.
WHAT IF IT’S YOUR FRIEND? OR SPOUSE?
Often business associates are friends. And many owners are inclined to deduct the cost of entertaining these friends.
You still need to follow the rules of being able to substantiate that the meal or event qualifies for the deduction.
“Just because you’re friendly with the person doesn’t bar the deduction, but it has to be legitimate,” Weltman said.
If your client brings a spouse or significant other along, chances are you can only deduct what you spend on your client’s entertainment. But if it’s the sort of event where everyone brings a mate, it might be acceptable. In any case, consult a tax professional.
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