This time we look at expenses for meals and entertainment and how they are deductible.
Is all M&E deductible?
Q: Are all business meal and entertainment expenses deductible?
A. Unfortunately, no! The tax rules for deductibility of business meals and entertainment (M&E) have rigorous requirements. These can only be deducted as business expenses when they are “directly related” or “associated” with the active conduct of a trade or business. Lacking a valid business purpose, the expenses are not deductible (and the employee may have to report the value of the expenses in their income). Upon establishing a valid business purpose, the M&E expense falls into one of two categories: 50 percent deductible or 100 percent deductible.
What’s a valid business purpose?
Q. How are M&E expenses established as having a valid business purpose?
A. All business expenses must meet the general deductibility requirement of being “ordinary and necessary” for carrying on business. With regards to M&E, the principal purpose for each event must be “directly related” to furthering business and the expectation of attaining specific, concrete business benefits. An expense may qualify as “associated with” the active conduct of business if the event precedes or follows a substantial and bona fide business discussion.
What’s half deductible?
Q. Having established a valid business purpose, which expenses are deductible under the general 50 percent limitation?
A. All expenses not subject to the 100 percent deductibility exceptions - which I’ll get in to under the next question - are subject to the 50 percent limitation. These include meetings with clients, customers and vendors at your place of business, a restaurant, or other location; meals while traveling away from home on business; and expenses while attending a business convention, business meeting or business luncheon. Related taxes and tips are also included in the amount that is subject to the 50 percent limit.
What’s 100% deductible?
Q. Which expenses are 100 percent deductible?
A. While many business owners are frustrated to discover that valid expenses are subject to a 50 percent limitation, few realize there are exceptions to that. It requires some specificity to indentify the exceptions but here are some that are among the most common:
Office Snack/Coffee Bar - Employers can deduct 100% of the cost of providing employees with free soft drinks, coffee, snacks, donuts and other similar items that are consumed on the business premises, as long as the expenses are relatively minor and difficult to track.
• Employee parties - The cost of providing food and beverages at company outings, holiday parties, or other gatherings primarily for the benefit of rank-and-file employees and their guests can be fully deductible.
• Items provided to the public - Expenses related to meals provided to the general public are fully deductible. These may include free samples offered by a retailer, cookies furnished by a realtor at an open house, hot dogs given away at a car dealer, food offered in an office lobby, and similar situations.
• Charitable-sponsored sporting events - The ticket cost to a qualifying charity sporting event (such as a charity golf tournament) is fully deductible, even when meals are included. To qualify, the charity must give 100 percent of its net proceeds to a charity and primarily staff the event with volunteers.
• Client reimbursed expenses - If meal expenses are incurred while providing service to a client, and those expenses are separately accounted for and billed to the client, a full deduction is then available to the service provider. (The client is then stuck with the 50 percent disallowance rule.) If separate billing doesn’t occur, the 50 percent disallowance applies to the service provider.
• Meals served on an employer’s premises - On-premise meals furnished for a valid business reason and for the employer’s convenience are 100 percent deductible. Valid business reasons making the on-premise meal a matter of employer convenience will vary based upon the taxpayer’s circumstances, but may include security issues, efficiency, the need for specific employees to handle business emergencies (including during the lunch hour), and the maintenance of workforce control.
Receipts work, right?
Q. So all I need to deduct M&E expenses are my receipts?
A. The receipt is a starting point, but more than a receipt is required. The IRS requires careful, detailed records be maintained to substantiate that each business meal and entertainment event has a valid business connection. While a receipt may substantiate amount spent, time, and place, it will not provide the business purpose and the business relationship with the individuals involved. As memories can fade quickly, it should be company policy to record such information when the expenses are submitted.
Got a tax question you would like answered? E-mail it to email@example.com . General interest questions will be answered in future columns but it might not be possible to answer specific questions. BeachFleischman PC, 1985 E. River Road, is Southern Arizona’s largest CPA firm. Advice is not intended or written to be used, and cannot be used for the purpose of avoiding penalties under the Internal Revenue Code or applicable state or local tax law provisions. This column appears the first and third weeks of each month.