MEALS AND ENTERTAINMENT
Maximizing The Tax Benefits
Expenses you are entitled to deduct
By Javier Goldin, CPA, MBA July 2012.
Objective: This Guide shows you how to take all of the travel and entertainment expenses you’re entitled to. It tells you which expenses are deductible, what percentage of them you can deduct, and it familiarizes you with the IRS’ rules for keeping records and substantiating your expenses. The key to understanding the full extent of the deductions allowed is to first understand what expenses may be deductible and then determine whether the meals and entertainment expenses are a) 100 percent deductible, b) 50 percent deductible and c) non-deductible. 1. What may be deductible For Whom are Entertainment Expenses deductible? Expenses for entertaining clients, customers or employees may be deducted if they are both ordinary and necessary and meet one of the following tests: Directly-related test: The main purpose of the entertainment activity is the conduct of business, business was actually conducted during the activity and the taxpayer had more than a general expectation of getting income or some other specific business benefit at some future time.
There is a presumption (in the eyes of the IRS) that events that take place in what it considers places non-conducive to doing business are not directly related to your business. These places include nightclubs, theaters, sporting events or cocktail parties. It also includes meetings with a group of people who are not business associates, at cocktail lounges, country clubs, or athletic clubs. However, you can overcome the presumption by showing that you engaged in a business discussion or otherwise conducted business during the event. Associated test: Even if you can’t show that the entertainment was "directly related" as discussed above, you can still deduct the expenses as long as you can prove the entertainment was "associated" with your business. To meet this test, the entertainment must directly precede or come after a substantial business discussion. Further, you must have had a clear business purpose when you took on the expense. In circumstances where it's customary to entertain a business associate with his or her spouse, and your spouse also attends, entertainment of both spouses is deductible. You do not have to show that business income or other business benefit actually resulted from each entertainment expense. 2. How much is Deductible?
• De Minimis Fringe Benefit Amounts — meals, entertainment and other employer-provided benefits that are relatively minor and difficult to track. Examples would include free soft drinks, snacks, etc. provided to office employees, as well
• • •
as certain corporate picnics and similar events. Note that more elaborate events where the cost per person is relatively high (e.g. a higher-end holiday party) may not fall within the de minimis exception. Charitable-Sponsored Sporting Events — tickets or packages involving sporting events where the proceeds are payable to a registered charity, and the event is staffed primarily by volunteers. Employee Compensation Amounts — to the extent the employer reports the meal or entertainment expenditure as W2 income to employees other than “insiders,” the amount will be deemed fully deductible. For example, a teambuilding fishing lodge trip reportable to the participating employees will generally be fully deductible. Obviously not a popular option for the employee, but can often be very tax effective. Reimbursed Expenses — to the extent a corporation incurs such expenses on behalf of a client/customer and there is an adequate accounting of such expenditures, such expenses will generally be fully deductible. Meetings of Business Leagues, etc. — costs associated with various IRC 501 organizations. Items Available to the Public or Sold to Customers — trade show costs, receptions, etc. open to the general public, or seminars/conferences/entertainment/ etc. open to the general public or for which customers/clients pay for attendance. Meals Provided to Certain Employees Working at Remote Locations — including, oil platforms, vessels and certain long-haul truckers.
To avoid problems qualifying for a deduction for dues paid to professional or civic organizations, document the business reasons for the membership—the contacts you make and any income generated from the membership.
Expenses that meet the “directly and associated related tests” and are not in the 100% deductible.
TIP: The most frequent reason for IRS’s disallowance of T&E expenses is the failure to show the place and business
purpose of an item. Therefore, pay special attention to these aspects of your record-keeping. Keep a diary or log book. Each expense for lodging away from home, as well as each other type of expense away from home for $75 or more, must be supported by receipts. The receipt must show the amount, date, place and character of the expense. Make the entries at or close to the time the expense is incurred.
Supporting Documentation for Meals and Entertainment expenses
The amount of each separate expense, though incidentals may be totaled on a daily basis. • • • The date of the entertainment. The name, address, and type of entertainment—e.g., "dinner," or "show"—but only if the type of entertainment is not obvious from the place name. The business reason for the entertainment and the nature of any business discussion that took place. Note: For business meals, you do not have to write down the nature of the discussion, but you or your employee must be present. The name, title, and occupation (showing business relation) of the people you entertained.
The fact that there are effectively three pools of meals and entertainment expenses to classify (100% deductible, 50% deductible and 100% non-deductible) makes it critically important for taxpayers to set up separate general ledger accounts to properly categorize the exact type of expense in order to quickly and accurately determine the tax deductibility of each item. Otherwise it is often difficult, if not impossible, for the corporate tax department or CPA firm to determine the proper tax treatment months or over a year after the expenses have been incurred. Many taxpayers simply end up adding back 50 percent of ALL meals and entertainment expenses for simplicity, or due to lack of understanding of the aforementioned rules.