- Ordinary and Necessary
- Directly-Related Test
- Associated-With Test
- Substantiation Requirements
An often asked question is: are meals and entertainment deductible in the course of one’s business, and if so, under what circumstances? This type of expense requires you to comply with some pretty complicated qualifications, and if you can jump through the hoops, the expenses may be deductible in certain cases.
But before we go too far, know that unreimbursed meal expenses incurred while out of town overnight on business are always deductible but generally limited to 50% of the cost. The focus of this article is the deductibility of meals and attendance at events in the form of business entertainment.
The first hoop to jump through is meeting the “ordinary and necessary” requirement, which applies to all deductible expenses needed to carry on a business. Ordinary and necessary is broadly defined to mean customary or usual and appropriate or helpful.
The next hoop is meeting one of two tests: the “directly-related test” or the “associated-with test.”
- Directly-Related Test – In order to meet the directly-related test, the meal expense must be incurred in the active conduct of business and be for the taxpayer, business guest(s) and any spouse(s). Under the directly-related test, actual business discussions are required during the meal, and the taxpayer must show that he or she anticipated a specific business benefit from the meal, even if the benefit never materialized. Meetings or discussions that take place at sporting events, nightclubs, or cocktail parties – essentially, social events – wouldn’t meet this test.
- Associated-With Test – The associated-with test is somewhat more liberal, because it allows deductions for meal or entertainment expenses incurred the same day either directly preceding or following a substantial and bona fide business discussion. However, entertainment can still pass muster, even if it didn’t occur on the same day as the business meeting, if the facts and circumstances warranted a delay.
Entertainment at shows, sporting events, night clubs, etc., can qualify under the associated-with test if its purpose is to get new business or encourage the furtherance of a business relationship. For meals, you or one of your employees must be present; otherwise, the expense is not deductible.
If non-business guests are invited to an otherwise allowable “associated-with business” entertainment event, the expenses must be allocated between the business and nonbusiness guests. The expenses related to the non-business guests are nondeductible. However, the spouses of the taxpayer and of his or her business guests or associates are considered business guests for this purpose.
Still another hoop is the restriction for lavish expenses. Meal and entertainment expenses are deductible up to an amount not considered “lavish” (reasonable under the circumstances). Also, the taxpayer (or a representative of the taxpayer) must be present. The representative could be, for example, the taxpayer’s employee, an attorney or an independent contractor who performs significant services for the taxpayer.
The final hoop, which is as important as qualifying for the deduction, is meeting the substantiation requirements. You must be able to establish the amount spent, the time and place, the business purpose and the business relationship and names of the individuals involved. You should keep a diary, account book or similar records with this information and record the details within a short time of incurring the expenses – a timely kept record carries more weight in an IRS audit than one created months or years after the event occurred, when memory can be hazy. For expenses of $75 or more, documentary proof (receipts, etc.) is also required.
A final word: even after you have jumped through those hoops, in the majority of cases, only 50% of the qualified expenses are actually tax-deductible. If you have any questions related to business meals and entertainment expenses, please give this office a call.