Do you struggle determining what meals and entertainment expenses are subject to the 50% limitation? You might not be taking full advantage of the deductions you are entitled to. This article will explain the general rules relating to meals and entertainment, and the exceptions to the 50% limitation.
Entertainment expenses that are incurred while entertaining a client, customer or employee are deductible if they are ordinary and necessary. An expense is ordinary if it is common and accepted in your trade or business. An expense is necessary if it is helpful and appropriate for your business.
In addition to being ordinary and necessary, the expenses must meet one of the following tests:
- Directly-related test
- Associated test
Directly-Related Test
When determining if you meet the directly-related test you should ask yourself the following questions:
- Was the main purpose of the combined business and entertainment the active conduct of business?
- Did you engage in business discussions with the person during the course of the entertainment?
- Did you have a general expectation of getting income or other specific benefit at a future time from the entertainment activity?
Associated Test
When determining if you meet the associated test, you must ask yourself the following questions:
- Is the entertainment associated with the active conduct of your trade or business?
- Did the entertainment occur directly before or after a substantial business discussion?
50% Limit
Generally, business-related meals and entertainment are subject to a 50% limitation on deductibility.
The 50% limit applies to meals and entertainment incurred while traveling away from home, entertaining customers or attending a business meeting.
Exceptions to the 50% Limit
The following describes meals and entertainment expenses that are 100% deductible:
- Food and Beverages for Employees – Expenses for food and beverages furnished on your business premises primarily for employees. For example, during group meetings, mentoring, on occasion if overtime work is required, during conferences, seminars or training schools.
- Recreational and Social Expenses for Employees – Recreational, social, or similar activities, or associated facilities incurred primarily for the benefit of employees who are not highly compensated employees. For example, a holiday party, an annual event, a seasonal outing and the cost of renting a bowling alley, swimming pool, charter boat, baseball diamond, etc.
- Organizational Business Meetings – Business meetings that are directly related to the taxpayer’s employees, stockholders, agents or directors. For example, meetings that introduce new procedures, the election of directors, discussion of corporate affairs or attendance at a conference, training seminar or training school that is not on your business premises.
- Expenses Treated as Compensation – Meal and entertainment expenses that are included as compensation to the recipient employee.
It is critical that proper records are maintained to substantiate all meals and entertainment deductions. Proper documentation includes a record of the time and place, business purpose and the relationship to the party being entertained.
To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.