When it comes to meals and entertainment, the IRS takes the view that there is no free lunch. At least not for you. But, for your business guests and employees, there is. Confused? Let us shed some light. The IRS rules are aimed at reigning in abuses. The fear is that people will try to write-off their regular bed and board under the guise that these are business meals. As you can see, the IRS view of what is deductible is very limited and the burden is on you to prove you qualify. So, what qualifies? In short, meals that have a “business entertainment” purpose are 50% deductible (i.e., your guest’s meal is free) and meals that are offered at the office for the benefit of employees and staff are fully 100% deductible.
Business Purpose for the Meal: Directly Related to or Associated with the Active Conduct of the Corporation’s Trade or Business
It has been said that one should never mix business and pleasure. The IRS agrees wholeheartedly. Even for qualifying meals, there are limits to what the IRS will allow. Business meals are deductible if they qualify as “ordinary and necessary” under Sec. 162 and not “lavish or extravagant.” A quick bite at Panara or Starbucks is generally fine, but a 3-martini lunch at Old Homestead or Masa might not be – that is unless you are putting the fine points on a deal to sell your business for millions or courting Warren Buffet to bring your company public. The meal must be directly related to or associated with your business activities. You must keep detailed records identifying the person you entertained and their connection to your business (prospect, vendor, employee, business partner, etc.) as well as the business purpose for the meal (planning, strategy, negotiation, etc.). You are relatively safe wining and dining clients, employees and professional advisers. You can even buy them a round on the IRS. But, don’t try to get a romantic meal with your spouse or significant other past the IRS unless you are bringing them as your plus-one for a formal dinner with several attendees. And, don’t overdo it. An all-night booze fest at a microbrewery, bottle service at a night club, or “entertainment” at a gentleman’s (or gentlewoman’s) cabaret is probably something you don’t want to try to justify to an IRS auditor. Just ask Justin Bieber! So, don’t push the envelope unless this kind of outing is customary in your particular field of business.
The location of the outing must be “conducive to business.” And the “main purpose” of the outing must be to conduct business. So, going back to our night club example, it is hard to explain how someone in such an environment could conduct business, let alone hear themselves think. So that would be an example of a forum that is not particularly “conducive to business.” All “ordinary and necessary” expenses are deductible, but they do not need to be indispensable. A company bowling party or catching a Cirque du Soleil show are probably fine provided there is a business portion to the event in a meeting room, dining area, or the like right before or after the “entertainment” event.
It is often said that “What Happens in Vegas, Stays in Vegas.” But, not if you are audited. Which leads to our next topic – substantiating your meals & entertainment expenses.
Substantiating Your Expenses
To substantiate meals and entertainment expenses you must show:
- The amount of each separate expense;
- The date, time, place and type of entertainment;
- The business purpose and nature of any business discussion that took place; and
- The business relationship and the name, title, and occupation of the individuals you entertained or dined with.
The IRS Meals & Entertainment Audit
An IRS tax audit is: “a review/examination of an organization's or individual's accounts and financial information to ensure information is reported correctly according to the tax laws and to verify the reported amount of tax is correct.”
General Rules to Know to Audit Proof Your Books & Records
Here are a few general tax rules to be aware of:
- 50% Limitation Versus 100% Deductibility: When meeting or entertaining clients, you do not get credit for your portion of the meal, but only for the tab for your guest. This is the 50% limitation. The rationale for this is that you have to eat anyway and the IRS isn’t providing you a tax break for your own enjoyment. Conversely, however, meals at the workplace for your staff during a training are 100% deductible. Examples include the holiday party, bagels for breakfast for the staff, a company training luncheon, or dinner for employees working late, etc.
- Recordkeeping: Using a dedicated business credit card is one of the best practices for ensuring that you can get credit for business-related meals & entertainment. American Express is the best in class due to the fact that they provide comprehensive categorization of your business expenses for convenience in getting your business write-offs. Always identify the “business purpose” and the prospective “business benefit” arising from the meal and wherever possible save your receipts (or take iPhone photos of them and upload to an App) with the name of your guest, purpose and hoped-for benefit all identified on the back side of the receipt for the meal.
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