May, 2010 Tax Newsletter

Business Entertainment – It’s Fun, but Make Sure It’s Deductible

The thing that makes it enjoyable for me to write the articles for my website each month is that I get the opportunity to share with my readers the tax experiences I share with my clients.  The seeds for virtually all my articles were planted by one or more of my clients that raised questions either during tax return interviews or by phone calls or e-mails about tax issues that were relevant to their situations.  One topic that often came up was business entertainment.

Perhaps you remember several years ago the stories about the IRS and its promised attack on the three martini lunch.  It is true that taking a client out to lunch is a basic and enjoyable experience, but it is necessary to comply with established tax rules.  The IRS, in its ongoing battle with businesses over entertainment expenses, is looking for companies that take excessive deductions or combine business with personal expenses.  The following is a brief discussion of the guidelines that a business owner needs to understand and observe.

Business entertainment encompasses a broad range of activities in addition to lunches and dinners, including taking clients to sporting events, the theater, or enjoying a round of golf at the club.  The IRS rules can limit the deductions for these activities.  As an example, playing a round of golf and having a meal with a client at a country club may very well be acceptable, but deducting the club membership dues is not.  A common misconception is that business entertainment, even if it meets all the qualifications for deduction (discussed below), is only deductible to the extent of 50%.  Also, the IRS can disallow any portion of the expenses if it considers the amount lavish.

IRS rules that the main purpose of the entertainment must be the “active conduct of business”.   A business owner must have “more than a general expectation of getting income or some other specific business benefit at some future time”.  However, it is permissible to deduct the cost of the meal or entertainment if it takes place directly before or after a business discussion.  So, if a client comes to your office for a business discussion and you then take him to dinner or a sporting event, it would be deductible.  While an actual receipt is not required if the meal or entertainment item is less than $75, there is still a documentation requirement.  Therefore, the who, what, where, when, and why of the entertainment must be documented.

Regarding tickets to events, if the cost benefits charitable organization, the full amount is deductible.  If you give tickets to a client the IRS gives you a choice of treating it as entertainment (50% deductible) or a gift (limited to a $25 deduction).  Therefore, if the ticket was $100, you can deduct $50 as entertainment; if the ticket was $40, you can deduct $25 as a gift as opposed to only $20 if it was entertainment).