Entertainment, meal, and gift expenses are some of the available deductions a small business can take advantage of when filing their taxes. If you itemize enough deductions, you can potentially lower your taxable income and ultimately lower your tax bill you owe to the IRS. Naturally though, there are a slew of rules and requirements for entertainment, meal and gift expenses to properly qualify as a deduction. As a starting point, these expenses must be considered ordinary and necessary in your industry and to your business to qualify. Ordinary implies the expense is commonly accepted in your trade or industry. Necessary implies expenses that are helpful and appropriate for your trade or industry.
Gift expenses
The deduction limit for a gift is a flat $25 per person for a tax year. So for example, if you give a prospective client a ticket worth $130 for a lower-level seat at the Staples Center for a Los Angeles Lakers game, you can only deduct up to $25 for that item. One flexible option for gift expenses, in the case of sporting and entertainment tickets, is that if you do not attend the event with the recipient, you are given the option of either claiming the expense as a gift expense or entertainment expense. Choose whichever may be more advantageous for you. Treating it as an entertainment expense has some additional rules though.
Entertainment Expenses – Qualifying Tests
Assuming your entertainment expenses pass the ordinary and necessary business expense requirement for deductions, the next question to be asked is if those expenses meet the directly related or associated tests.
To be considered “directly related”, these criteria must be met:
- The main purpose is business.
- Business was conducted during the entertainment.
- You had more than a general expectation of income or some future business benefit.
An example of this could be the Presidents of two different companies getting together and playing golf while discussing details of a merger and how to carry it out.
The “associated test” is less stringent on expenses:
- Associated with the active conduct of the business.
- Substantial business discussion took place before or after the associated entertainment.
An example of this is a company holding a meeting discussing future business plans at their office then hosting a dinner event for its employees at a nearby steakhouse.
50% Limit
Generally, for all qualifying entertainment and meal expenses, you are only allowed to deduct up to 50% of the cost. There are some exceptions, such as self-employed people’s meals not subject to the deduction (so long as it is business-related) or costs related to attending a charitable sports event.
In all circumstances, maintaining detailed records is important for gift, entertainment, and meal expenses that you plan to claim as a deduction. Records of minutes of a meeting, who attended, receipts, invoices, and other notes can help you substantiate your answers in case the IRS may come knocking with questions. As a final comment, anything that appears lavishly expensive (e.g. luxury box seats at a sporting event) may disqualify an expense as deductible. So, use your best judgement and ask us as your accountant if your business expense truly meets the ‘ordinary and necessary’ requirements.
Hopefully you found this article on meal and entertainment expenses informative. We post business tax articles and other “good to know” pieces regularly. Follow us on our social media pages for future updates!
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