WHEN CAN YOU TAKE A TAX DEDUCTION FOR MEALS AND ENTERTAINMENT?

When you take a client to dinner or to a live entertainment venue, it may seem like you could deduct this from your taxes later. This is a common pratfall and has several rules attached before it can be counted as a deduction at the end of the year. In order for it to count in the first place, both meals and entertainment must be common practice in your industry and necessary to carry out. For example, a freelance programmer likely won't be taking a client to a baseball game, so it may not be deductible come tax time.

Regardless of whether it was a meal or an event, you will only be able to deduct 50% of the total expense at the most and there are exceptions, naturally. There are also two "tests" that the IRS applies when determining whether something you have listed can actually be a deductible or not. The first is called the "Directly Related Test" and the second is called the "Associated Test." If your deduction does not fit either of these two categories, it would be safer not to try to claim it at all.

Directly Related vs. Associated

In order for something to be considered "directly related," you must prove three things:

  1. The purpose of the event was to conduct business first and foremost.
     
  2. During the event, you conducted some sort of business with your client.
     
  3. You had more than just a general expectation that taking your client to the event would help gain income or a business-related benefit in the future.

Fortunately, you don't have to devote more time to business than pleasure during the event, just prove that taking your client to the event was with the intention of conducting business. The IRS also states that the event should be set in what they call a "clear business setting" to be considered Directly-Related. Examples of this include entertainment at an industry-related convention, a price rebate on the sale of your products, such as a restaurant giving a customer the occasional free meal, and almost any event designed to gain publicity.

The IRS does frown upon, and therefore may not acknowledge, certain venues and events. These include nightclubs, theaters, sporting events, cocktail lounges, country clubs, vacation resorts, athletic clubs and, despite what Hollywood might imply, golf clubs. If your meeting takes place at any of these places, there is a high chance it will not be considered "Directly Related," but it could still be considered "Associated."

For a function to be considered "Associated," you need to prove that it was associated with your business's active conduct and that it came directly before or after an important business discussion. The first point goes back to how normal it is in your industry as a whole to have such meetings in the first place, but the second point is a bit trickier. This is determined on a case-by-case basis, but you need to show that you actively participated in the business discussion or transaction. Once again, there are no constraints on time or even that the discussion took place during the meal or entertainment. The IRS's main concern is relevance.

What you Can and Cannot Deduct

The IRS's general definition of "entertainment" is pretty much what you would expect with the addition of everyone's needs, including room, food and transportation. The entertainment category is a bit tricky depending on your particular business, and will likely be outside your business's norm. If you are a gun maker and hold a gun show, this is not entertainment. If you are a gun maker and hold a concert for your employees, however, that's entertainment. One form of entertainment that is always deductible is a holiday party for your staff, so long as it isn't limited to a certain group of people within the company.

Be aware that if you and your business associates take turns paying for expenses for personal reasons, none of you can claim it as a deductible. You also cannot claim club membership fees, expenses for an entertainment facility that you own, such as a yacht, a swimming pool, a vacation resort and so on, or expenses for you, your spouse or your client's spouse. You also cannot deduct something if it is too lavish. For example, you can't claim a luxury limousine when all you needed was a standard rental car.

Phillip R. Christenson

Office, 3131 Fernbrook Lane N., Suite 224, Plymouth, MN 55447, USA

Phillip Christenson is co-owner and financial advisor at Phillip James Financial, a Fee Only Financial Planning & Investment Management located in Plymouth Minnesota and serving the surrounding suburbs. He has been published and quoted in many national publications such as the Wall Street Journal, Chicago Tribune, Investopedia, etc.