Deduct meals and entertainment on your tax return
Deducting meals and entertainment can be tricky – and it’s one of the first things an auditor will look at if they look at your business or employee deductions. You do have to dot your i’s and cross your t’s in order to deduct them, and there are limitations. But it can save you significant tax dollars to do so – let’s look at the rules.
Ordinary and necessary: All business expenses must meet the general deductibility requirement of being “ordinary and necessary” in carrying out the business. These terms have been fairly broadly defined to mean customary or usual, and appropriate or helpful. So if it is reasonable in your business or job to entertain clients or other business people, you should be able to pass this general test.
“Directly related” or “Associated with”: There is a second level of tests specifically applicable to meals and entertainment expenses. A business meal or entertainment must be either “directly related to” or “associated with” the business. “Directly related” means involving an “active” discussion aimed at getting “immediate” revenue. So a specific, concrete business benefit is expected, not just general goodwill. And, the principal purpose for the event must be business. Also, you must have engaged actively during the event, by a meeting, discussion, or something of the sort.
The “directly related” test can also be met if the meal or entertainment takes place in a clear business setting directly furthering your business – a setting in which there is no meaningful personal or social relationship between you and the others involved. Meetings or discussions at sporting events, night clubs, or cocktail parties – essentially social events – would not meet this test.
If the “directly related” test cannot be met, the expense may qualify as “associated with” the active conduct of business if the meal or entertainment event precedes or follows (takes place on the same day as) a substantial and bona fide business discussion. This test is easier to satisfy than the “directly related” test. “Goodwill” entertainment at shows, sporting events, or night clubs can qualify. 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 your employee) must be present. So, for example, if you cover the cost of a client’s meal after a business meeting but don’t join him for the meal, the expense does not qualify.
Substantiation: Almost as important as qualifying for the deduction are the requirements for proving that it qualifies. The use of reasonable estimates is not enough here. You must be able to show the amount spent, the time and place, the business purpose, and the business relationship of the individuals involved. Obviously, you must set up careful and detailed record-keeping procedures to keep track of each business meal and entertainment event and to justify its business connection. For expenses of $75 or more, documentary proof (such as a receipt) is required.
Deduction limitations: Several additional limitations apply. Expenses that are “lavish or extravagant” are not deductible. This is generally a “reasonableness” test and does not impose fixed limits on the cost of meals or entertainment events. Expenses incurred at first-class restaurants or clubs can qualify as deductible. Once the expenditures qualifies, it is only 50% deductible. Obviously, this rule severely reduces the tax benefit of business meals and entertainment. If you spend about $50 a week on qualifying business meals, or $2,500 for the year, your deduction will only be $1,250, for a likely tax savings of roughly $300 to $400.