En­ter­tain­ment expenses – make the most of the tax in­cen­tives

Parties, meals, cel­e­bra­tions, social events: these things are an integral part of the day to day life of many busi­ness­es. Being sur­round­ed by food and drink so often makes for the perfect setting for con­struc­tive business dis­cus­sion as well as a more relaxed occasion for employees to con­gre­gate. For en­tre­pre­neurs, business dinners are an important means of winning clients, fi­nal­iz­ing contracts, and main­tain­ing current client relations. When it comes to paying these company en­ter­tain­ment expenses, a company can benefit from various tax in­cen­tives – as long as you fulfill the necessary re­quire­ments.

The IRS has clearly set out what counts as a de­ductible en­ter­tain­ment expense. According to them, en­ter­tain­ment refers to any activity that has the aim of providing en­ter­tain­ment, amusement, or recre­ation, which of course includes meals provided to a customer or client. This includes things like service charges, coat room fees, nightclub entrance, etc. However, they also make sure to outline the two different sorts of company en­ter­tain­ment expenses that exist: directly related and as­so­ci­at­ed. These two variants are named “tests”:

• The directly related test means that the main purpose of the en­ter­tain­ment was to actively conduct business, which was engaged in during the course of the event and that you had an ex­pec­ta­tion of gaining future income or another business specific benefit as a result of the en­ter­tain­ment.

• The as­so­ci­at­ed test is where there are still clear business purposes for or­ga­niz­ing the event, or that the event took place im­me­di­ate­ly before or after a sub­stan­tial business-related dis­cus­sion. The IRS rec­og­nizes ‘before or after’ as usually meaning on the same day but is also willing to make ex­cep­tions to this rule if enough proof is supplied. Sub­stan­tial, in this case, means that it involved one or several dis­cus­sions on a business trans­ac­tion or some other activity that is specific to your company. It is worth noting that these IRS guide­lines do not specify how long an event needs to take.

The directly related and as­so­ci­at­ed tests mentioned above are crucial when it comes to de­ter­min­ing which tax, as well as how much tax, is ap­plic­a­ble to the company en­ter­tain­ment expense in question. The meal or event in question needs to have involved some sort of business dis­cus­sion or purpose, otherwise, it is in no way a de­ductible item on your tax report. Usually, with an en­ter­tain­ment expense, it’s the case that it is 50 percent de­ductible. However, there are some sit­u­a­tions where a business en­ter­tain­ment expense can be 100 percent de­ductible. These include:

• If a meal is provided on the premises of the employer and if more than 50 percent of employees are catered for by said meal
• If it’s a pro­mo­tion­al activity that is also made available to the general public as well
• If you purchase tickets to a char­i­ta­ble fundrais­ing event

With a business dinner, it is im­per­a­tive that there is as at least one person present who is not an employee of the company. Otherwise, this makes it an employee dinner/party—something that needs to be handled quite dif­fer­ent­ly when it comes to filing taxes. Although such events usually involve a current or potential business partner, it is not ex­plic­it­ly stated by the IRS that this needs to be the case. It could also be an event involving the likes of:

• Free­lancers
• Public officials
• Jour­nal­ists
• Advisors
• Tax authority auditors

Along with these external guests, it is also possible to invite employees who can support you during this business endeavor. When it comes to making tax de­duc­tions, these employees can only be con­sid­ered as another guest. The cost of their meal, drinks, etc. can only be seen as a 50 percent deduction and not a business expense that is 100 percent de­ductible.

With such occasions, the client feeling at ease and com­fort­able should be a priority for you and you should not hesitate to invite ad­di­tion­al guests. For example, if a client or business partner brings their spouse to a meal then the cost of their food, drinks, etc., this is also tax de­ductible. Fur­ther­more, this will allow you to bring your spouse or sig­nif­i­cant other and have their en­ter­tain­ment expenses deducted as well. The same thing applies to children, i.e., if your guest brings their children then you can also bring yours and these costs will also be 50 percent de­ductible. However, it is crucial that your client’s extra guests are present, otherwise, you cannot include your spouse, children, etc., in your tax de­duc­tions. This is the case even if your spouse is your sig­nif­i­cant other is your business partner or even a client.

Although it might seem like an obvious thing to say, in order to claim the expenses, you yourself need to be present at the event. In the past, people have bought event tickets for clients with the hope of being able to write them off as a business en­ter­tain­ment expense. Purchases like this are actually only subject to the ‘gift expense’ deduction, which is $25.

Whether you are or­ga­niz­ing a business dinner or a staff party, it’s important to keep an eye on the overall cost of such an event. The IRS not only checks out the reason for ex­pen­di­tures like this, it also checks the amount that has been spent. This is very important when it comes to tax de­duc­tions. You must make sure not to spend an excessive amount on these events otherwise the IRS will start to ask questions regarding the ex­trav­a­gant amount of money spent.

Whether the re­spec­tive company en­ter­tain­ment expenses are suitable for tax de­duc­tions, this is something that has to be assessed on an in­di­vid­ual basis using the criteria and tests mentioned above. In order to avoid nasty surprises, it is also probably worth cal­cu­lat­ing and budgeting for the cost of such en­ter­tain­ment events in advance. This should also allow you to make all the right prepa­ra­tions regarding taxation, paperwork, etc.

Re­gard­less of whether it’s a simple dinner, a Christmas party, or special occasion (an­niver­sary, etc.), it’s possible to save a lot of money through tax de­duc­tions. This money can then be invested in other aspects of the company. It is of utmost im­por­tance that the expenses are com­pre­hen­sive­ly and correctly doc­u­ment­ed and that all the required paperwork is available. Otherwise, this will lead to com­pli­ca­tions with the au­thor­i­ties later. 

Of course, it is important for you to have a suitable ac­count­ing system and to be aware of where and how details on en­ter­tain­ment expenses need to be booked. Equally important is that you fill out the right paperwork and hang onto the correct documents in order to prove the ex­pen­di­tures that have been made. Exactly how to go about dealing with en­ter­tain­ment expense receipts can be read about in these articles.

Click here for important legal dis­claimers.