There are a lot of rules overseeing tax discounts, but the area riddled with the most rules is entertainment. And the IRS loves to audit this line item on a business tax return. An IRS auditor, while holding back a laugh, will ask you a few simple questions knowing full well you may not know the rules. Next thing you know, your entertainment deductions have been blown out of the water. This is what works and what doesn’t when it comes down to deducting entertainment costs.
Firstly, entertainment expenses are only half deductible. Most tax software or your tax pro will ask you for the total spent on entertainment, so don’t split the amount in half. Give the grand total and the software or tax pro will do the rest.
An exception to the fifty percent rule is if you’re inviting the general public to an event you put on to promote your business. In this situation, it would be considered advertising expense and as such would be 100% deductible. Naturally, if your company is in the business of entertaining, the reduction is also considered an ordinary and obligatory business expense, and isn’t subject to the 50% cut. For example, if you own a bar and hire a band to entertain your customers, the price is 100% deductible.
To be deductible, the primary reason for the entertainment expense would be the active conduct of business. You need to attempt to make a sale or otherwise be doing business with the specific expectation of getting some monetary benefit out of the deal. If you are merely having an informal lunch with your tax pro talking sports, kids and fashion trends, then you don’t have a real deduction. Also, get rid of the idea of having the ability to write off a cocktail party where customers, prospective clients and business colleagues mingle essentially for the sake of networking. It won’t go over with the IRS. Now if you were going to have a product demo or a lecture about the service you provide prior to opening the wine and serving the hours devours, then you’ll be allowed to take an entertainment deduction.
The IRS doesn’t believe that business can be debated on hunting or fishing trips or while on board a yacht or any other pleasure cruise. So don’t even bother setting up that sort of entertainment because whether or not you can demonstrate a sound business reason, the deduction won’t sail.
Nor do they think that you can discuss business in a club setting, at a cocktail party, or in a sports event. Nevertheless you are permitted to have a business meeting linked with that sort of entertainment. If you meet with a potential customer, demo your product and give him your selling spiel, and then take him drinking and dancing or out to a ball game, you’ve got a legitimate write off.
The IRS doesn’t take time into account: So long as you’ve got a substantial business discussion, it does not need to be longer than the entertainment provided.
The IRS also requires that entertainment cannot be “lavish and extravagant.” This is a reasonably subjective term, and I imagine what your small company would consider handsome and indulgent might differ just a bit from Donald Trump’s views. So keep the bills down if you don’t wish to raise some eyebrows. You risk losing the whole deduction if the IRS doesn’t consider the expenses a reasonable amount.
If you have lunch once each week with a customer or business associate and you take turns picking up the check, you probably will not have a deduction. Remember, there must be a significant business discourse with the expectation of making a sale so as to qualify the entertainment expense.
Entertaining your staff is one hundred percent deductible. So if you’ve got an office party for your staff, you are permitted to write off the whole expense. If nonetheless it’s a mixed party, say with 20 staff, 5 clients and 15 family members for a price of $300 then you’re permitted to write off 100 percent of the price tag attributed to the staff share, half the price attributed to the client share and none for the family memebers.
The same rule applies to employee meals. If you provide meals for staff because you want your workers to stay in the office for lunch so you order in a pizza then you’ve got a 100% write off.
Expenses less than $75 don’t require invoices, just make sure you have all the information written down i.e. time, place, who, etc. With that said, it’s easier to just keep the invoice. Be terribly careful about writing off dues to certain clubs: country clubs, golfing and athletic clubs, airline clubs, and hotel clubs aren’t deductible.
Entertainment facilities such as timeshares, cabins, yachts, swimming pools, etc. are also not deductible business entertainment expenses. There is a case of an entrepreneur audited by the IRS who was refused the pro rate share of mortgage interest, property taxes, depreciation and other expenses for the corporate usage of a cabin he owns. Even though he maintained logs demonstrating business use and had allotted the expenses accordingly, the IRS didn’t permit him to write it off because the cabin was considered to be an entertainment facility.
One of the most important things to remember is substantiation. Picture yourself in front of an auditor making an attempt to validate a deduction. Do you have a copy of the invite to your party that states there’ll be a product demonstration prior to the festivities? Have you got the name of the persons entertained noted on the receipt? Do you have the trade show flyers listing the associated entertainment? If you entertain people in your house, be totally sure to keep more than the grocery store receipt. An auditor will simply roll his eyes as he proclaims “disallowed.” So be sure to keep a copy of the invite that contains a line item mentioning the business reason. Keep all these things in your tax file just in case an audit.
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