Let’s go over the IRS basis for these deductions and provide some real-world examples. The General Rule is you can deduct expenses which are ordinary and necessary to entertain to the following:
- Client – this case would be once you have secured a meeting with a new business prospect, the meeting place, meals and associated costs can be deducted within reason.
- Customer – You have a customer with whom you want to expand your services, review current service, etcetera and you have a meeting in which a meal and entertainment may be provided.
- Employee – One example here would be the celebration of a milestone for an employee(s) such as Performance goals have been met or exceeded favorably, accident free time, efficiency measures are met, birthday, tenure, promotion, etc.
The term “Ordinary” expense would be a cost in which the industry in which you are in is considered standard. An example here would be a Conference Meeting of your peers which would have a training seminar and the cost of the meals and entertainment would be out of your pocket. Of course the cost of the training would be deductable, and the meals and entertainment would also be deductable under a separate category.
A “Necessary” expense would be one which is considered appropriate such as a barber shop which has a Drink Barista available for waiting customers. These costs can be deducted in this category.
We now have to consider what is called a “Directly Related test” and an “Associated Test.” The guidelines here are:
- With Directly Related costs, they must have been in a business setting, the purpose of the entertainment was the active conduct of business, and there was an engagement of business with an expectation of a relationship to follow.
- Concerning the Associated Test, this type of entertainment is considered standard practice within your peer group, and it was a part of the function before and/or after the meeting.
Another point to consider for the business owner is to beware of double dipping business expenses! You may not deduct any of these expenses if you are also using them as a travel expense. An example here would be a meal expense incurred during the trip to a business meeting with a client. The in-flight meal and its associated expenses before the actual client meeting would be considered a travel cost. Also remember expenses that are considered excessive or lavish cannot be deducted.
The IRS guidelines with reimbursement expenses are such that you can only deduct 50 % of your unreimbursed expenses. It is important to remember to segregate your expenses into the above categories to test reasonableness and qualifications.
For more detailed guidelines please review IRS Publication 15, Publication 535, Publication 463 and Publication 334.