Understanding the Meal and Entertainment Tax Deductions

Meals and entertainment can be used as deductions on your business tax returns as long as certain requirements are met. The IRS recognizes the use of meals and entertainment is needed to conduct business. Some examples of the use of these types of activities are to acquire new clients, entertain existing clients, and to hold a social event for employees to build goodwill and team camaraderie.

The number one rule when deciding whether or not a meal or entertainment expense can be used as a deduction on your tax return is if the activity had a legitimate business purpose. There are three requirements for the meal and entertainment deduction:

  1. Be a qualified meal or entertainment
  2. Have a necessary relationship to your business activities
  3. Be supported by adequate records

We will look at each requirement in detail below.

Requirement #1: Be a Qualified Meal or Entertainment

Qualified activities include activities intended to provide entertainment, amusement or recreation. This would, of course, include meals but also other types of entertainment activities. Examples of such activities would be sporting events, hunting trips, and concerts. Hotel stays for an out of town client, for example, could also be considered an entertainment type activity.

The IRS allows businesses to deduct 50% of the meal and entertainment activity as long as it is not considered lavish or extraordinary in the eyes of the IRS. The reason why only 50% is allowed is because the IRS assumes that you would still eat even if you didn’t have a business purpose for the meal. The meal deduction includes the cost of the food, drinks, tax, and tips.

However, there are some situations in which 100% of entertainment expenses can be deducted. A holiday party or company picnic may be deducted in its entirety as long as all employees are allowed to attend, thus making it a true employee social gathering. It is important to note that even though 100% may be deducted, it can only be up to face value. For example, if you purchase scalped tickets worth $50 for a baseball game for $75 only the $50 value of the tickets can be deducted.

Requirement #2: Have A Necessary Relationship To Your Business Activities.

The meal or entertainment expense must be related closely with the operations of the business. In order to determine this, the IRS has two tests that if you meet at least one of them then you would qualify for this requirement.

Test #1: Directly Related Test

The meal or entertainment activity must be directly related to the business and must take place in a clear business setting. If, however, the activity is not in a clear business setting the activity can still qualify as long as it meets the following three requirements:

  1. There must be an expectation of producing income or a clear business benefit from the activity.
  2. The primary topics of discussions were related to the business.
  3. The entire purpose of the activity is to conduct business.

Test #2: Associated with Test

This test is more lenient and you can qualify if you meet these two requirements:

  1. The meal or entertainment is associated with the on-going operations of the business.
  2. The meal or entertainment activity happens immediately before or after a business activity or discussion.

For example, if members of a company are at a trade show in another state but go to a meal directly after a trade show meeting, then the meal would qualify as it is associated with the business activity.

Requirement #3: Be Supported by Adequate Records

Just like any other item that involves your tax records you must keep adequate records, as deemed by the IRS, to substantiate any deduction on meal and entertainment. It is advisable to keep these records for up to four years as the IRS can challenge your return for up to three years after the filing year.

The records must show two things: what the expense was for and how much was the expense. Examples of appropriate records would be receipts, invoices, and canceled checks. The more detail the better. You should be able to keep a record of all details surrounding the expense such as the amount of the expense, time of the activity, location of the activity, business purpose of the activity, individuals involved, and the relationship of the individuals involved.

The key is to be as detailed as you can so if the IRS wants to audit your records they will be confident in your record keeping ability. If a document looks recreated, that will be a red flag and the IRS will think your other documents are suspect.

As long as you adhere to these three requirements you should be able to claim meal and entertainment activities that are for a business purpose. If in doubt it is advisable to seek the advice of an accountant as they will assist you with looking at this through the lens of the IRS.